Understanding an Income Statement (Format, Definition and Examples)

An Income statement is a financial statement that shows you the company’s income and expenditures. It also shows whether a company is making a profit or loss for a given period. The income statement, along with the balance sheet and cash flow statement, helps you understand the financial health of your business.

What is income statement?

An income statement is a financial statement that shows you the company’s income and expenditures. It also shows whether a company is making a profit or loss for a given period. The income statement, along with the balance sheet and cash flow statement, helps you understand the financial health of your business.

The income statement is also known as a profit and loss statement, statement of operation, statement of financial result or income, or earnings statement.

The statement is divided into time periods that logically follow the company’s operations. The most common periodic division is monthly (for internal reporting), although certain companies may use a thirteen-period cycle. These periodic statements are aggregated into total values for quarterly and annual results.

This statement is a great place to begin a financial model, as it requires the least amount of information from the balance sheet and cash flow statement. Thus, in terms of information, the income statement is a predecessor to the other two core statements.

WHAT GOES ON AN INCOME STATEMENT?

While all financial data helps paint a picture of a company’s financial health, an income statement is one of the most important documents a company’s leadership team and individual investors can review, because it includes a detailed breakdown of income and expenses over the course of a reporting period. This includes:

  • Revenue: The amount of money a business takes in during a reporting period
  • Expenses: The amount of money a business spends during a reporting period
  • Costs of goods sold (COGS): The cost of component parts of what it takes to make whatever it is a business sells
  • Gross profit: Total revenue less COGS
  • Operating income: Gross profit less operating expenses
  • Income before taxes: Operating income less non-operating expenses
  • Net income: Income before taxes less taxes
  • Earnings per share (EPS): Division of net income by the total number of outstanding shares
  • Depreciation: The extent to which assets (for example, aging equipment) have lost value over time
  • EBITDA: Earnings before interest, depreciation, taxes, and amortization

These may be further divided into individual line items, depending on a company’s policy and the granularity of its income statement.

For example, revenue is often split out by product line or company division, while expenses may be broken down into procurement costs, wages, rent, and interest paid on debt.

Disclosures

Certain items must be disclosed separately in the notes (or the statement of comprehensive income), if material, including

  • Write-downs of inventories to net realizable value or of property, plant, and equipment to recoverable amount, as well as reversals of such write-downs
  • Restructurings of the activities of an entity and reversals of any provisions for the costs of restructuring
  • Disposals of items of property, plant, and equipment
  • Disposals of investments
  • Discontinued operations
  • Litigation settlements
  • Other reversals of provisions

Format

Fitness Equipment Limited
                                  INCOME STATEMENTS
                                    (in millions)

  Year Ended March 31,                         2019          2020           2021
 ----------------------------------------------------------------------------------
  Revenue                                  $14,580.2      $11,900.4      $8,290.3
  Cost of sales                             (6,740.2)      (5,650.1)     (4,524.2)
                                         -------------   ------------  ------------
  Gross profit                               7,840.0        6,250.3       3,766.1  
                                         -------------   ------------  ------------

  SGA expenses                              (3,624.6)      (3,296.3)     (3,034.0)
                                         -------------   ------------  ------------
  Operating profit                          4,215.4       2,954.0        732.1  
                                         -------------   ------------  ------------

  Gains from disposal of fixed assets           46.3            -             -
  Interest expense                            (119.7)        (124.1)       (142.8)
                                         -------------   ------------  ------------
  Profit before tax                          4,142.0        2,829.9         589.3
                                         -------------   ------------  ------------

  Income tax expense                        (1,656.8)      (1,132.0)       (235.7)
                                         -------------   ------------  ------------
  Profit (or loss) for the year          $  2,485.2     $  1,697.9     $   353.6  

Earnings per share

Because of its importance, earnings per share (EPS) are required to be disclosed on the face of the income statement. A company which reports any of the irregular items must also report EPS for these items either in the statement or in the notes.

{\displaystyle {\text{Earnings per share}}={\frac {{\text{Net income}}-{\text{Preferred stock dividends}}}{\text{Weighted average of common stock shares outstanding}}}}{\text{Earnings per share}}={\frac  {{\text{Net income}}-{\text{Preferred stock dividends}}}{{\text{Weighted average of common stock shares outstanding}}}}

There are two forms of EPS reported:

  • Basic: in this case “weighted average of shares outstanding” includes only actual stocks outstanding.
  • Diluted: in this case “weighted average of shares outstanding” is calculated as if all stock options, warrants, convertible bonds, and other securities that could be transformed into shares are transformed. This increases the number of shares and so EPS decreases. Diluted EPS is considered to be a more reliable way to measure EPS.

Importance of an income statement

An income statement helps business owners decide whether they can generate profit by increasing revenues, decreasing costs, or both. It also shows the effectiveness of the strategies that the business set at the beginning of a financial period.

The business owners can refer to this document to see if the strategies have paid off. Based on their analysis, they can come up with the best solutions to yield more profit.

Following are the few other things that an income statement informs.

  • Frequent reports: While other financial statements are published annually, the income statement is generated either quarterly or monthly. Due to this, business owners and investors can track the performance of the business closely and make informed decisions. This also enables them to find and fix small business problems before they become large and expensive.
  • Pinpointing expenses: This statement highlights the future expenses or any unexpected expenditures which are incurred by the company, and any areas which are over or under budget. Expenses include building rent, salaries and other overhead costs. As a small business begins to grow, it may find its expenses soaring. These expenditures may involve hiring workers, buying supplies and promoting the business.
  • Overall analysis of the company: This statement gives investors an overview of the business in which they are planning to invest. Banks and other financial institutions can also analyze this document to decide whether the business is loan-worthy.

What is the difference between an income statement and a balance sheet?

A balance sheet shows what a business owns and how much it owes at a specific point in time. An income statement shows what a company earned and spent over a period of time.

The Bottom Line

An income statement provides valuable insights into various aspects of a business. It includes a company’s operations, the efficiency of its management, the possible leaky areas that may be eroding profits, and whether the company is performing in line with industry peers.

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