Every public company is mandated to file periodic financial statements. These are part of every company's quarterly and annual reports. These financial statements also appear in documents such as a stock offering or the filings that accompany a merger or acquisition. The all-important financial statements are a balance sheet, cash flow statement, and an income statement (also known as a profit and loss statement.) Each provides a specific sort of view on the company's performance over the period covered in the filing, whether that is the previous fiscal quarter or year.
The income statement, also know as a profit and loss statement, is a vital part of financial analysis, as it provides the all-important bottom line. That is, in its simplest form, the single-step income statement, the accountant simply adds revenues with other gains and subtracts them from the sum of expenses and losses. On the other hand, the multi-step method for creating income statements, on the other hand, provides more detail and distinguishes the individual sorts of revenue, expenses, and other losses. For example, on multi-step income statements, items such as operating expenses will be distinct from cost of goods sold. In a similar fashion, a multi-step income statement will delineate net income into categories such as income from investment and sales revenue. While a single-step income statement is often adequate for many financial analysts, a multi-step income statement provides the sort of detail a managerial accountant would need.
The income statement covers several aspects of the company's operations including:
- Revenue
- Costs
- Gross Profit
- Rent, Utilities, and other Expenses
- Taxes
- Cost of Goods Sold
- Profit or Loss
- Net Income
- Income Tax Expense
- General and Administrative Expenses
Since this filing covers the all-important issues of profits and loss, it is tempting to consider this the most important statement. However, while analysts rely on the income statement for vital data, it must be placed in the context of the other two filings.
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What Does the Income Statement Cover?
The income statement covers a lot of financial territory and thus it can become the cornerstone of an analysts view on the company. After all, this statement covers an issue that is seemingly vital to the success of any company, profit.
The fundamental formula at the core of every income statement is:
Net Income = (Total Revenue + Gains) – (Total Expenses + Losses)
There are two types of revenue that analysts review - operating and non-operating revenue. Operating revenue comes from activities such as sales of a product or income from services rendered. Non-operating revenue is income the company has realized through activities that aren't central to the company. For instance, a shoe manufacturer might realize non-operating revenue from equity investments, real estate sales, or interest gained from banked capital. Gains are also income from non-core activities such as the sale of equipment, real estate, or other one-time events.
Expenses and losses are realized from core business practices such as payroll expenses, taxes, rent, and investment in raw materials. Secondary expenses can include things like an interest payment or loan origination fees. Losses might include things like fines, losses due to accident or weather events, or other one-time debits to the company's bottom line.
What Doesn’t it Cover?
Though the income statement is vital to any comprehensive picture of a company's fiscal condition, it does not cover everything. For one thing, this statement does not quantify the company's overall worth; that is what the balance sheet reflects. Nor does the income statement show the company's current cash position and its ability to pay debts and other expenses. Thus, creditors will be less interested in the income statement and more interested in the cash flow statement and the balance sheet.
The income statement does not cover receipts, nor does it show any cash outlays or disbursements. While elements from the balance sheet and CFS are found on the income statement, and vice versa, each statement is independent and should be considered as such.
Income Statement Structure
Income statements are always structured in the same way. This consistency helps analysts, creditors, and investors read and understand the statement with ease.
The purpose of the structure is to lend depth and detail to the core formula that each statement demonstrates:
Net Income = (Total Revenue + Gains) – (Total Expenses + Losses).
Income Statements follow this order:
- Revenue
This includes items such as funds received from the sale of goods, income from services rendered, and other monies directly related to the core business of the enterprise. - Operating Expense
This includes the cost of business administration, cost of good sold, and other operating expenses (such as rent, utilities, fuel for equipment, etc.). - Gains
These are generally one-time bursts of revenue or perhaps income related to non-core financial activities. Gains can include a one-time sale of equipment, interest revenue, equity sales, or perhaps a settlement resulting from litigation. - Losses
Losses are the flip side of gains. They reflect one-time losses or debits resulting from non-core business activities. If the company's investments were to post losses, that would be recorded here. Other losses can include expenses related to litigation, accidents, or extreme weather events.
When a company files this information with the SEC on a quarterly statement (10-Q) or on the Annual Report (10-K), a discussion follows each financial statement. This discussion section is where the company's accountants can clear up any questions or ambiguities. One-time and non-core business expenses and gains particularly need an explanation, as investors need to know the nature of any tremendous positive or negative spike in revenues.
What’s it Used for?
The income statement is used as a source of information for shareholders, analysts, and creditors to help make determinations as to the company's overall fiscal condition, including gross profit. In particular, this statement shows how well the company was able to profit in the period covered in the statement. It can show overall expenses and revenues in that quarter or year, which lends greater context to the other statements. Income statements can also show great detail including items like the cost of goods sold, a breakdown of operating expenses, and a delineation of revenue (income) sources. When used in conjunction with the balance sheet, for instance, the income statement can help show turnover in inventory or accounts receivable. When the total sales from the income statement is divided by accounts receivable, for instance, an analyst can determine how well accounts receivable have turned over in the given period.