WHAT IS INCOME STATEMENT?
The income statement is one of the important primary financial statements provided by organizations. It presents the results of a company’s operations for a given reporting period. Along with the balance sheet, cash flow statement and the statement of changes in owners’ equity, the income statement is also one of the essential means of financial reporting. It indicates whether or not the firm has made money during the period reported.
The income statement examines a particular period of time of the business, considering all the expenses and income received in that time-span and breaks it down until only net income remains. It provides information regarding risk, financial flexibility, return on investment and operating capabilities involved in a business
TERMS OF INCOME STATEMENT:
- The operating section of an income statement includes revenue and expenses
- The non-operating section includes revenues and gains from non-primary business activities, items that are either unusual or infrequent, finance costs like interest expense and income tax expense
REVENUES: Revenues are cash inflows based on production and delivery of goods and other activities constituting the company’s major operations. One can simply put it as the money received from the sale of products and services before the expenses are taken out, also known as the top line.
Examples of revenues are sales revenue, interest revenue and rent revenue.
NET INCOME:Net income also called the bottom-line is the excess of all revenues / gains over all expenses / losses of the period. These are post the deductions of finance costs, depreciation and taxes. On the other hand, Net loss is the excess of expenses and losses over revenues and gains for a period.
OPERATING REVENUES AND EXPENSES: This section includes the revenue and expenses. Revenues are the cash inflows or other enhancement of the assets while the expenses are the cash outflows or using up the assets or incurrence of liabilities.
Cost of Goods Sold: This is the direct cost attributed to the goods produced and sold by the entity. It includes material costs and direct labor costs.
Selling General & Administrative expenses: This includes the employee cost excluding labor costs. Besides, it includes the expenses incurred for the selling of goods and other administrative activities.
Depreciation and amortization: These are charges towards fixed assets and intangibles that are capitalized on the Balance Sheet for the specific accounting period.
OPERATING PROFITS: These are the operational benefits after the expenses are deducted from the revenues. These indicate the operational efficiency and strength of the company.
NON OPERATING REVENUES AND EXPENSES:
This includes revenues from non core business activities like rent or patent income, expenses such as foreign exchange loss, unusual / infrequent gains or losses, finance costs and income tax expense.
Discontinued operations are those operations of an enterprise that have been sold or disposed. The results of continuing operations must be reported separately in the income statement from discontinued operations. Results from discontinued operations are reported net of income taxes.
Extraordinary gains or losses are unusual and infrequent in occurrence. Extraordinary items could result if gains or losses were the direct result of a major casualty, such as an earthquake, a prohibition under a new act or regulation. These are also reported net of income taxes.
Earnings Per Share (EPS): Earnings per share data provides a measure of the company’s management and past performance and enables users of financial statements to evaluate future prospects and assess dividend distributions to shareholders.
METHOD FOR CONSTRUCTING INCOME STATEMENT
The income statement can be prepared in either of the two formats, single-step or the multiple-step format.
Single Step format:
This format totals all revenues and gain items at the beginning of the statement. All expense and loss items as a total are deducted from the total revenues, giving the net income.
Net income = Revenues – Expenses
|Gain on sale of assets||3,000|
|Cost of gooods sold||75,000|
|Office supplies expenses||3,500|
|Office qpuipment expenses||2,500|
|Loss from lawsuit||1,500|
Multi step format:
This format presents the operating revenue at the beginning of the statement and non-operating gains, expenses and losses at the end of the statement. However, various expenses are deducted throughout the statement at intermediate levels as well. The statement presents several important aspects, such as operating income (Ebidta), gross margin on sales, income before taxes (PBT) and net income (PAT).
|Cost of goods sold||300|
|Other operating expenses||100|
|Profit Before Tax||318|
|Net income from continuing expenses||289|
|Non recurring events|
Extraordinary items, gains and losses, discontinued operations are always shown separately at the bottom of the income statement, regardless of which format is used.
Each format of the income statement has its advantages. The single-step format has the advantage of being relatively simple to prepare and understand, while the multiple-step income statement provides all important financial and managerial information that the user otherwise has to calculate from a single-step income statement.
ADVANTAGES OF INCOME STATEMENT:
Provides detailed information on revenues:The income statement provides detailed data on revenues. Besides the normal costs such as the cost of goods sold (COGS), employee expenses, operational expenses, it also accounts for additional costs like taxes applicable. Similarly, on the revenue front, it accounts not only for revenues earned from sales but also factors in for revenues gained from non operational components like interest accrued by different investments. Hence, the income statement is an ideal source for complete revenue information.
Database for Investor Analysis: It is an important document for investors who need detailed information before investing into any company. It provides all the data from sales to profits, operational efficiency to other non operational aspects. All this cumulatively helps investors get a clear picture of how the business is and expected to be. Thus, it is a single source to judge the condition of a company.
Other benefits: The income statement shows the profitability of the company over a period of time. The company can determine the major revenues it has earned. Secondly, it is significant because it is based on the matching principal and shows the expense incurred by a company to earn the revenues. From an investment perspective, shareholders of a company are interested in the net income because the dividends are paid out of the total income. Moreover, income statement also helps the companies analyze their expenses and take into account the major streams of operating revenues of the company.
DISADVANTAGES OF INCOME STATEMENT:
Misrepresentation of data:The income statement includes not only current revenues gained from sales but also the money due from accounts receivable which the business has not paid yet, just as it includes liabilities as expenses that have not actually been paid yet. Also, the large one-time expenses or revenues can drive the income sharply up or down from what it actually should be. This leads to misrepresentation of the success of the company
Other factors:The income statement helps in gauging the earnings per share and other past financial data, but it does not provide with data on the expected future growth. It does not give any indication on how the revenue generation happens. A business may be underpaying employees and overcharging customers to create its profits, practices that will eventually cause business problems but show as positives on the financial document. Any investor looking into the income statement has to have these additional factors also in mind before taking any financial decision. One needs to remember that the income statement is considered as a fiction because it is based on accrual accounting and it does not provide cash transactions. Free cash cannot be calculated through income statement
Business decision making, is both art and science. Along with the other financial statements, a business owner has to pay close attention on the income statements as well. Successful business planning involves balancing a range of variables and options, relying on experience and judgments as well as strong conclusions drawn through firm numbers.