An income statement is one of the more important financial statements you can look at for business. Business owners, accountants, current investors and prospective investors alike can glean crucial information for themselves from a company's income statement, also known as the profit and loss statement.
The income statement combines with other major financial statements, the balance sheet and the statement of cash flows, to provide an overall outlook on a business's finances, what is going well and what needs improvement.
So if you're interested in how well a business is doing, you should understand the income statement. What is the income statement, what is included in it and what can you learn from it?
What Is an Income Statement?
The income statement of a company is a financial statement that details the revenue a company makes compared with the expenses it incurs, thus why it can also be referred to as the profit and loss statement. It shows the net earnings of a company, while generally detailing how that figure was determined.
Financial statements like the income statement can be found, among other places, in the company's 10-K, a yearly report the company has to file with the Securities and Exchange Commission (SEC). There is also the 10-Q, a quarterly version of the report.
In addition to the more general overview of the company's future provided in the 10-K are several financial statements one can peruse. Using this larger report, you can look at the income statement along with the balance sheet and the statement of cash flows for a more clear picture of the company's operations.
Single-Step Income Statement vs. Multiple-Step Income Statement
There can be single-step income statements and multiple-step statements. The difference between them is pretty easy to ascertain.
If you're looking at a single-step income statement, you'll get to look at how much the company made in revenue and gains, how much was incurred in expenses and losses and what the net income was for the fiscal year or quarter based on those numbers. However, that's all that will be available to you on this income statement. Each section is a single line.
If you want the details within all these figures, you'll need a multiple-step income statement. Here, it breaks down what was part of each category and how much each component made or lost for the company to determine its net income for the fiscal period. The specifics that will make up the bulk of a multiple-step income statement will depend on the industry the company works in and a variety of expenses and gains specific to that fiscal period.
Structure of an Income Statement
The income statement finds the net income of a company, which is described as total revenue minus total expenses. Thus, structurally we start from the gross income from the revenue the business brought in and work from there to get to the net income. Depending on how many different causes of revenue or expenses the business had, this might involve a lot of different figures.
With that in mind, an income statement will start with the total revenue generated by the business, and from there will subsequently, should it apply to the business, have the cost of goods sold (COGS) subtracted from it. This equation gives us the company's gross profit.
Once you've calculated gross profit, the next section of the income statement is operating expenses. Operating expenses are, simply, the general expenses that come with running a business. This can include:
- Sales commissions
- Advertising expenses
- Marketing expenses
- Office supplies
- Legal fees
- Compensation and benefits for non-production employees
- Depreciation of certain fixed assets
Not all of these will apply to any given company. Not every business requires advertising expenses. Some companies will have to factor depreciation more heavily into operating expenses than others, and these companies might not have the administrative costs other companies do. But a template might include room for all of these in your income statement, just in case.
Once you've subtracted the operating expenses from the gross income, you have calculated what is known as a business's "operating income." If there are no other gains and losses to factor into the company's finances, that operating income can also be its net income.
However, if there are gains and losses made throughout the relevant fiscal period that goes beyond operating revenue and expenses, those are added to the income statement next. Often, these are one-time expenses specific to that fiscal period and not a usual loss or gain; for example, gains from selling an unused piece of real estate.
Once these non-operating figures are factored in, you have everything you need to determine the net income. Add up the revenue, operating or otherwise, and then subtract expenses - also operating or otherwise - and you'll have your net income. Or, if the business ends up with more expenses than revenue for the fiscal period, it's known as a net loss.
Income Statement Format
With all of this in mind, an income statement for a company could look like this:
- Sales - $15,000,000
Cost of Goods Sold (COGS) - $7,000,000
Gross Profit - $8,000,000
- Advertising Expenses - $1,000,000
- Research & Development - $1,000,000
- Rent - $500,000
- Office Supplies - $100,000
- Wages - $1,500,000
Total Operating Expenses - $4,100,000
Operating Income - $3,900,000
Non-Operating Income & Expenses
- Investment Gains - $500,000
Net Income - $3,950,000
What Can an Income Statement Be Used For?
The income statement can be used to view just how healthy a business's finances are - and, using a multiple-step income statement, the specifics as to why business is or is not financially thriving.
With the details of how much money has gone toward various operating expenses, business owners can have a clearer picture of the company's strengths and shortcomings and develop a better understanding of how the company needs to be managed for it to be successful. Prospective business owners and entrepreneurs can also look to other businesses ' income statements to see what mistakes they should look to avoid when they start their business.
Income statements can also be of good use to investors as well. In addition to showing the details of how the company's net income is calculated, an income statement is also likely to have the same data for the fiscal year or quarter before comparison's sake. With this information, you can better analyze if a company is getting financially stronger or if its expenses make a further decline likely. Though not the be-all and end-all, it is a useful tool if you are interested in seeing if this particular company will be a worthy investment for you in the immediate future.