What is an Income Statement?
Definition: Income statement, also known as profit and loss statement, is a report that shows how a company or business performed, financially, over a given accounting period. The report offers insights on the revenue generated as well as expenses incurred and net income or loss.
Income statement is one of the four main financial statements issued in addition to the balance sheet, statement of owners’ equity and statement of cash flow. Income statement differs from the other financial statement as it sheds more light on a company’s operations by highlighting, efficiency of the management as well as its performance relative to the overall industry.
The income statement is one of the most important financial statements, especially for public companies. In the U.S, public companies must submit to the Securities and Exchange Commission their quarterly income statement to showcase business performance. The income statement heading lists the company name and duration, which can be fiscal year or quarter ended.
Income Statement Format & Components
Four key items are taken into consideration when preparing income statement- revenue, expenses, gains or losses. The financial statement does not factor in money received by the business let alone cash payments or disbursements paid out.
Operating and Non-Operating Revenue
In the preparation of the income statement, total revenue takes into consideration the sum of both operating and non-operating revenues. Operating revenue, in this case, is the revenue generated from primary activities, which could include the sale of products or services.
Non-operating revenues, on the other hand, are realized from non-core business activities. The revenues, in this case, are accrued from activities outside the core business. Non-operating revenue may include interest earned on capital in the bank, rental income or earnings from strategic partnerships
Gains
A gain, which is an important component in the preparation of an income statement, refers to money earned from other activities not tied to the core business. Gains may include the sale of long-term assets, or earnings made form one-time non-business activities. Returns from the sale of unused land let alone a subsidiary company are often treated as one-time events, thus leading to short-term gains.
Expenses
Any business must incur expenses to continue operating and churn in some profits. Total expenses in income statement include expenditure incurred in both primary and secondary activities. Primary expenses include all costs incurred to earn a normal operating revenue and include costs of goods sold as well as selling general and administrative expenses.
Secondary activity expenses include all expenses linked to no-core business activities, which can be interest, paid on loan money.
Primary revenue and expenses indicate how well a company’s main activities are performing. In contrast, secondary revenues and expenses indicate a company’s effectiveness in managing non-core activities. For instance, higher interest on money stored in the bank could be a sign of inefficiency in the utilization of funds in the bank
Income Statement Formula Preparation
The statement starts with the sales made during the accounting period and then works down to the computation of net income, which often leads to earnings per share in the case of public companies. Conversely, the income statement gives an outline of the revenues generated, leading to net income or loss.
Net income = (Revenue + Gains) –(Expenses +Losses)
Income Statement Uses
The main purposes of an income statement are to show how a business or company performed over a given accounting period. The profit and loss statement can, therefore, be used to compare business performance across a given sector or industry.
Income statements are also prepared at the department segment level to provide valuable insights on the progress of various operations. While such reports may remain interim, they provide valuable information for making informed decisions.
Management relies on income statements to make decisions on matters such as expansion into new geographies as well as the pushing of sales into new markets or increasing production capacities.
Investors and research analysts rely on income statements to see whether efforts of reducing costs for sales are having an impact on profits. Likewise, such statements can be used to make investment decisions in the financial markets.