The income statement is one of three core financial statements required by a company to show its profits and losses during a period of time. Calculating those profits or losses is by subtracting all expenses, from all revenues during that time. That will include all operating and non-operating activities.
The balance sheet and statement of cash flows are the other two core financial statements. However, in this article, we are only focussing on the income statement, the components that make it, with an example.
Companies then divide those income statements into periods that follow the operations of the company in the best way. Most companies use a monthly basis; however, some prefer to have thirteen regular cycles of four weeks. Either way is excellent, so long as it fits your operations, and you do not change the times. You then combine those periodic statements into total numbers for quarterly and annual reports.
The income statement is the best place to begin a financial model of your company because it requires the least amount of information. Furthermore, it is from this statement that you make a lot of assumptions about future earnings.
Factors Of An Income Statement
All companies are different, and as such, will require various elements and components. Furthermore, income and expenditure will be separate for each operation style, too. However, there are some general similarities between the majority of them, and it is those general items that we will run through in this section.
- Cost of goods
- Gross profit
- Operating income
- Pre-tax income
- Promotion expenses
- Administrative and general expenses
- Interest expenses
- Income taxes
- Net income
Now we will take a little look into each of those components and how they fit into the income statement.
Sales, Revenue, Or Net Sales
All of these terms are interchangeable on an income statement. It refers to the value of the sales of goods or services from the company to its customers. Although this is not the most exciting line for investors, it is undoubtedly the most important for business growth. Some companies will have various revenue streams, but they all add together to create this revenue line.
Cost Of Goods Sold (COGS)
The type of company you run will determine what this line will comprise. However, in basic terms, it is the cost of materials, labor, overheads, etc. used for the production of the items or services that you sell. For example, if you are a wholesaler or retailer, you will put the initial cost of those merchandise here. For a manufacturing plant, you would use the prices of raw material, labor, and factory running costs. If you have a service business, the cost of sales is the labor used.
Also known as gross margin or gross income, it is merely the difference between net sales and COGS. However, it is this line that shows the amount of money left to cover all of the other expenses for the business. The higher this line, and the more stable, the more significant the potential for a better bottom line, or net income.
Earnings Before Interest, Tax, Depreciation, and Amortization. This line is not present in all income statements, but we feel like it is worth going over. That is because investors or analysts can use EBITDA to analyze profitability and compare it to other companies or industries. The considerable difference between EBITDA and gross profit is that EBITDA will not take into account any capital investments such as equipment or properties.
There is no legal requirement for the disclosure of EBITDA. However, the Financial Accounting Standards Board (FASB) sets out in the Generally Accepted Accounting Principles (GAAP) that the EBITDA is obtainable through other information on an income statement.
Operating income, or Earnings Before Interest and Taxes (EBIT), is the primary indicator of the profitability of a company. You calculate EBIT as your revenue minus expenses. However, you have to exclude tax and interest. Therefore, it is the profit before any non-operating fees or non-operating income, interest, or tax.
Pre-tax income, or earnings before tax, is the net income that a business earns before the deduction of any taxes. However, the pre-tax income does account for all deductions relating to depreciation, interest, and operating expenses.
Promotion expenses are the costs of items provided to customers for free. For example, if you are handing out samples of your product for testing, or if you are offering free services to the general public. However, the amount of promotion expense is not the market value, but it is the cost of the service or goods.
Administrative And General Expenses
Administrative and general expenses, when included in an income statement, are all of the costs that you can not account for with a specific business function or operation. G&A expenses can consist of things like insurance, utilities, rent, legal fees, etc. You can only call an expense Administrative and general if it affects the whole business and not one part of the operation.
Interest expenses are all incurred costs from borrowed funds. It is a non-operating expense on the income statement. Any expenses under the interest expenses category will be the accumulated interest payable from any borrowing, such as loans, bonds, credit, or convertible debt. Furthermore, on the income statement, the interest expense represents the amount of interest accrued during the period, not the amount paid.
Income tax is the tax that you pay, at whatever the rate is that you pay it, to the Government based on your taxable income. However, it is not the paid income tax; it is an estimate that the company expects to pay.
Net income is the line that people are interested in the most, the bottom line. This line is the most significant indicator of a company’s total profitability. If your combined expenses exceed your combined income, this line will show a loss. If you would like to know more about how to calculate Net income, click here.
Sample Income Statement
Now that you understand all of the aspects that go into an income statement, we will take a look through a sample of ABC company.
Please bear in mind that this is a simple income statement, and some will have more figures for itemized sales, etc. However, using this sample, you can work out that from sales of goods, ABC Company makes a bottom line of 21% of their total product or service sales. Furthermore, you can compare two years side by side to see what differences there are in each sector. That will often allow you to create business plans to increase your bottom line, based on facts of percentage increase or decrease in items such as the cost of goods.
Income Statement – Conclusion
Although an income statement may seem challenging to complete, it will become more comfortable with practice. One of the most valuable tips that I have learned is to try completing an income statement each month, or quarter, to enable you to gain knowledge, understanding, and proficiency before the time comes that you need to do one.