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Income Statement

Income Statement

The definition, components and layout of an income statement are explained here under the following segments:

1. What is an Income Statement?

2. Components of an Income Statement

3. Income Statement Approach

4. The Layout of an Income Statement

 

1. What is an Income Statement?

An income statement provides details on the financial performance of an organization for a financial year or accounting period. It is one of the standard financial statements that have to be prepared by an entity for accounting purposes.  The income statement is a summary of the income and expenditure of a business, which shows the profit or loss incurred for a specific period.

Every organization, company or business is required to prepare financial statements on a periodic or annual basis. Publicly quoted companies have an obligation to forward their annual reports to regulatory authorities, investors and other stakeholders such as IRS and the companies’ registry.

Apart from the income statement, the balance sheet, and statement of cashflows provide useful information on a company’s financial health. The information sought by stakeholders on Revenue, net income and profitability can be seen in an income statement.

2. Components of an Income Statement

The information disclosed in an income statement covers a given period and the performance of a company is revealed in the Revenue, expenses, and profit before tax. The earnings per share can also be a pointer to the profitability of a company for a period under review.

The income statement displays information under the operating and non-operating segments. Income and expenditure that arose from the regular operations of a company come under the operating segment. Other income and expenditure that arose from operations that are not of a regular nature are shown under the non-operating segment.

A business that deals in fashion merchandise will have regular income from Revenue of fashion accessories. If the business decides to sell off some of its office buildings, then the profit on the Revenue proceeds will be listed under the non-operating segment of the income statement.

3. Income Statement Approach

The multi-step approach or the single-step approach is acceptable for use when preparing the income statement. The income statement can be prepared using either of these two known methods.

The single-step approach presents gross income as revenue less the sum of production and cost of materials. The operating income is arrived at by deducting the sum of administrative, marketing, and research and development cost from gross income. The operating income and gross income are visible in every income statement.

The multi-step approach presents each item from revenue to profit after tax in a detailed manner with each item recorded as an entry.

4.  The Layout of an Income Statement

The following is the layout of an income statement.

Revenue

This is also described as sales or turnover, and it is the aggregate value of the company’s services and/or goods sold to customers during the period under review.

As the first item on the income statement, revenue is significant as its value will ultimately affect the gross profit and net earnings respectively. 

Cost of Goods Sold

This can also be called cost of services, and is often referred to as COGS. For a company that has a production process; labor cost, direct overheads on manufacturing and raw materials will make up the cost of goods sold. For example, a departmental store will state the cost of goods sold as the value of purchases made less any unsold stock.

Other businesses that offer services to customers will state their cost of sales as the cost incurred for the services rendered.

Gross Profit

Another name for this is the gross margin or gross income. The gross margin of a company is the funding source for other expenses other than the direct production cost or cost of sales.

A sufficient margin will fund all operational expenses with the resulting balance shown as net profit.

Selling, General, and Administrative Expenses

Products or services that are offered to customers attract some cost, and this is the basis for selling, general and administrative expenses.

Management control over this category of outflows is important so that the gross profit is not eroded by expenses incurred during the underlying financial period.

By benchmarking this expense category as a percentage of revenue, managerial efficiency is detected by a performance reviewer.   

Operating Income

Operating income arises when selling, administration and general expenses are deducted from gross profit. This represents the company’s earnings from regular activities and is a reliable basis for the measurement of a company’s profitability. 

Other expenses like interest charges and taxes are exempted in arriving at the operating income.

Interest Expense

Financing cost incurred by a company is reflected as interest expense. An optional method of reporting this item is to deduct interest income from interest expenses before reporting the net.

Profit Before Tax

Also known as pretax income, this item is a measure of profitability that analysts pay attention to when reviewing a company’s financial statements.

 Since tax assessed on a company’s profit is not always based on a straight-line function, analysts prefer to use this item instead of profit after tax. 

Many companies resort to several tax avoidance schemes, and this makes profit after tax less reliable when reviewing a company’s performance.

Income Tax

Tax is accepted as the other certainty in life apart from death. The income tax stated in an income statement is estimated and only gets paid after agreement with the tax authorities.

While it has to be provided for in arriving at the profit after tax, what gets paid in the final outcome as tax can be higher or lower than the earlier amount provided.

Special Items

An extraordinary or special item can either be an income or an expense. Since this item is not certain, it is regarded as a departure from the normal course of business.  Examples include income or charges arising from discontinued operations, business restructuring or some nonrecurring activity.

A financial statement analyst will pay careful attention to this item as it can significantly distort the trend of a company’s financial indicators.

 Net Income 

This is also referred to as net earnings or net profit after tax. The net income shows if a company is profitable or not. When an income statement shows a net loss, it indicates that expenses exceeded income for the year or period under review.

Payments made in respect of dividends are deductions from net income before transfers are made to reserves. The net income arising after these deductions is termed retained earnings, and it is added to a company’s opening equity for the financial year under review.

Earnings Per Share

You can expect to see supplemental entries after earnings after tax that might indicate (EPS) earnings per share or diluted earnings per share as the case may be

EPS is calculated by dividing the earnings after tax and preference share dividends by the company’s shares in issue.

Diluted EPS is calculated by adding convertible securities to the shares in issue before arriving at the earnings attributable to each share.

Comprehensive Income

The presentation of comprehensive income has become a standard feature in an income statement. This item shows the impact on the net income by such entries as unrealized losses or gains attached to investments and adjustments for pension liability. It also shows possible gains and losses incurred with respect to foreign currency translations.

 

The essence of the entries identified here is to provide an insight on market volatility and their possible impact on a company’s financial results when and if they occur.

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