A company’s financial performance and trends can be measured and tracked via its income statement.
Canva
What Is the Income (Profit or Loss) Statement?
The income statement details a company’s revenue and expenses to demonstrate profitability for a period. For publicly traded companies, the income statement is one of three statements that compose the financial statement filed with the Securities and Exchange Commission on a quarterly and annual basis. The income statement is also referred to as the profit or loss statement.
The other two statements are the balance sheet, which shows a company’s assets and liabilities, and the cash flow statement, which shows how a company’s cash is managed and utilized. Some companies also publish a fourth statement known as shareholders’ equity, which shows debt and equity attributable to stockholders. Shareholders’ equity usually appears on the balance sheet. In short, the income statement is a snapshot of a company’s ability to generate profit, after subtracting expenses from revenue.
What Are the Components of the Income Statement?
The following are the main sections typically included in a company’s income statement. Some companies use different names to refer to certain components.
Revenue
Revenue is the beginning of the income statement. It is the top line item that shows money generated from the sale of goods and services.
Cost of Goods Sold
Cost of goods sold represents the direct cost tied to the purchase of raw materials and producing a finished product.
Gross Margin
Gross margin, or gross profit, is a subtotal for profit that shows how much income is generated from sales after deducting cost of goods sold.
Operating Expenses
Operating expenses are indirect costs, which include expenses for research and development, marketing, and executives’ salaries.
Operating Income
Operating income is a subtotal for profit after operating expenses have been deducted from gross profit.
Interest Expenses
Interest expenses are tied to the cost of financing, such as payments for interest on loans and bonds.
Tax Payments
Tax payments refer to corporate tax paid to government.
Net Income
Net income is the end of the income statement. It is the bottom line figure that shows how much money remains after expenses have been deducted from revenue. All expenses are subtracted from revenue to calculate net income, and the net income formula below lists the expenses after revenue. A company would also break down net income into earnings per share and report the number of common shares outstanding used in that calculation.
Net Income = Revenue – Cost of Goods Sold – Operating Expenses – Interest Costs – Tax Payments
Net Income Formula
Net Income = Revenue – Cost of Goods Sold – Operating Expenses – Interest Costs – Tax Payments
Who Uses the Income Statement?
The income statement is a snapshot for corporate executives, investors, and analysts to gauge a company’s ability to generate profit over a period. Gathering income data over several periods could show whether a company has been able to sell more goods and keep costs for production and labor under control.
How to Interpret the Income Statement
Revenue and expenses are the main parts of the income statement, and interpreting them gives executive management, investors, and analysts an understanding of how costs are managed to produce profit for a period or over a set of periods.
In the example below for Apple, a 5-year compilation of its income statements show how its net income almost doubled with an increase in sales of its product and services while keeping expenses in check.
Apple lists its revenue as net sales, which is broken down by products (iPhone, MacBook, etc.) and services (Apps, Apple TV+, etc.). Apple saw a 33 percent surge in sales in 2021 from the previous year, but the company kept its cost of sales lower than net sales, which helped it book a large gross margin.
The rate of operating expenses held steady from 2018 to 2021, indicating that executive management was maintaining control over these indirect costs. There were no extraordinary items recorded in 2021, so the remainder of expenses were straightforward, leading to an outsized gain in net income.
Frequently Asked Questions (FAQ)
The following are answers to some of the most common questions investors ask about the income statement.
What Does the Income Statement Show?
The income statement shows how profitable a company is by listing its revenue and expenses. Its executive management team can determine, based on the data, whether to reduce expenses in a particular area, such as in operating expenses or cost of goods sold. If interest costs are rising, executives can work with a bank to refinance its loans, for example.
Is the Income Statement Prepared First?
A company usually prepares the income statement first to break down its revenue and expenses. The items listed here help to fill out other parts of the financial statement such as the balance sheet and shareholders’ equity.
Who Prepares the Income Statement?
A company’s internal finance and accounting team prepares the income statement, and for publicly traded companies, an auditor signs off on the financial statement as a seal of approval.
What Is Not Shown in the Income Statement?
Items that don’t fall within the guidelines of generally accepted accounting principles are not shown in the income statement. Non-GAAP items derived from the income statement include adjusted EBIT and EBITDA. Net income also would not show cash flow, assets and liabilities, and other items that would appear in the cash flow statement and the balance sheet.
What Is Income Statement Pro Forma?
Income statement pro forma shows how a company’s income statement would appear for projected outcomes if certain adjustments were made, sometimes made on the expectation of attracting potential investors. Some companies, such as startups, use pro forma to show investors how they would achieve profitability for their company if specific costs were removed.
How Is the Income Statement Prepared?
The income statement first gathers revenue and then the direct costs involved with production, namely costs of goods sold. Indirect costs, such as marketing and research and development, are then deducted. After all expenses have been accounted for, the net income figure shows profitability.
How Is the Income Statement Related to the Balance Sheet?
The income statement contains items relevant to the balance sheet. Net income that is reported for a period will also appear as part of retained earnings, which is listed under shareholders’ equity.
