What Is An Income Statement And How To Read Income Statement?
What Is An Income Statement?
The income statement is one of the three main financial statements used to report a company’s financial performance over a specific accounting period. The other two important statements are the balance sheet and cash flow statement.
The income statement focuses on a company’s income, expenses, gains, and losses over a specific period of time. Also known as a profit and loss (P&L) statement or statement of income and expenses, the income statement describes a company’s operations, its management’s performance, underperforming areas, and its performance relative to industry peers.
KEY TAKEAWAYS
The income statement is one of the three main financial statements, along with the balance sheet and statement of cash flows, that report a company’s financial performance over a specific accounting period.
The income statement focuses on a company’s income, expenses, gains, and losses over a specific period of time.
The income statement provides insight into a company’s operations, its management’s performance, areas of underperformance, and its performance relative to industry peers.
Understand The Income Statement
The income statement is an integral part of a company’s performance reports that must be filed with the US Securities and Exchange Commission (SEC). While the balance sheet provides a snapshot of a company’s finances as of a certain date, the income statement reports earnings over a specified period, usually a quarter or a year, and is headed up by that period. indicates, which can be read as follows (financial). For the year/quarter ending June 30, 2021.
The income statement focuses on four main components: revenue, expenses, profit and loss. It does not distinguish between cash and non-cash receipts (cash sales vs. sales on credit) or cash vs. non-cash payments/disbursements (cash vs. purchases on credit). It starts with sales details and then works to calculate net income and finally earnings per share (EPS). Basically, you calculate how the net income earned by the company converts into net income (profit or loss).
Income And Profits
The income statement covers the following, although its format may vary, depending on local regulatory requirements, the variable scope of the business, and related operating activities:
Operating Income
Income generated from core activities is often referred to as operating income. For a company that manufactures a product or a wholesaler, distributor or retailer is in the business of selling that product, revenue from core activities refers to revenue from the sale of the product. Similarly, for a company (or its franchisees) in the business of providing services, income from core activities refers to the income or fees received for providing those services.
Non-Operating Revenue
Income generated from secondary, non-core business activities is often referred to as recurring passive income. This income is derived from income outside the purchase and sale of goods and services and includes income from interest earned on business capital held in the bank, rental income from business properties, and strategic partnerships. It may include income such as royalty payment receipts, or income. From displaying advertisements placed on commercial property.
Benefits
Also called other income, profit refers to net income from other activities, such as the sale of long-term assets. These include net income from one-time non-business activities, such as the sale of an old truck business, unused land, or a subsidiary.
Income should not be confused with receipts. Payment is usually made in the period in which sales or services are rendered. Receipts are cash receivables and are counted when the amount is received.
A customer may purchase goods/services from a business on September 28, which will result in revenue on September. Due to their excellent credit and standing, the customer may be given a 30 day payment window, allowing payment up to 28th October, subject to invoicing.
Expenses and Losses
The cost of continuing the business and shifting profits is called an expense. Some of these expenses can be written off on your tax return if they meet Internal Revenue Service (IRS) guidelines.
Primary Activity Expenses
It is all expenses incurred to earn average operating income related to the core business of the company. Include cost of goods sold (COGS). selling general and administrative expenses (SG&A); depreciation or austerity; and research and development costs. Common items that make up the list are employee wages, sales commissions, and utility costs such as electricity and transportation.
Secondary Activity Expenses
These are all expenses associated with non-core business activities, such as interest paid on money borrowed.
Losses as Expenses
These are all expenses that go toward selling long-lived assets at a loss, one-time or other extraordinary expenses, or litigation expenses.
While primary income and expenses provide insight into how well a company’s core business is doing, secondary income and fees represent the company’s involvement and expertise in managing ad hoc and non-core activities. Significantly higher interest income on money in the bank, compared to income from the sale of manufactured goods, indicates that the company is not using available cash to full capacity by increasing productivity, or that it is experiencing challenges. In increasing your market share amid competition.
Recurring rental income from hosting billboards at the company’s factory along the highway indicates that management is taking advantage of available resources and assets to generate additional profits.
Income Statement Structure
He earned $25,800 from the sale of sporting goods and $5,000 from coaching services. He spent the various amounts of record on the particular activities totaling $10,650. He made a net profit of $2,000 selling a used truck, and made a loss of $800 settling a dispute brought by a customer. Net income for the given quarter is $21,350. The example above is the simplest form of income statement that any standard business can produce. It’s called a one-step income statement because it’s based on a simple mathematical process in which income and profits are added together and expenses and losses are subtracted.
However, real-world companies often operate globally, have diverse business sectors that offer a mix of products and services, and are often involved in mergers, acquisitions, and strategic partnerships. This wide range of operations, variety of expenses, diverse business activities, and the need to prepare reports in a standardized format for regulatory compliance result in numerous and complex accounting entries on the income statement.
Listed companies follow a multi-step income statement, which separates operating revenues, operating expenses, gains from non-operating revenues, non-operating expenses, and losses, and through the income statement prepared in this way provides more detail.
Essentially, the different measures of profitability are reported in the multi-step income statement at four different levels of business operations: gross, operating, pre-tax, and post-tax. As we will soon see in the following example, this separation helps to identify how income and earnings move/change from one level to another. For example, a higher gross profit with lower operating income indicates higher expenses, while higher pre-tax profit and lower after-tax profit indicates a loss of income due to taxes and other unusual overhead expenses.
Let’s look at an example based on the 2021 annual earnings reports of two large publicly traded multinational companies from different sectors: technology (Microsoft) and retail (Walmart).
Read Income Statements
The focus in this standard format is to calculate earnings/earnings on each subitem of income and operating expenses and then calculate mandatory taxes, interest and other one-time items to arrive at net income based on ordinary inventory. applies. Although the arithmetic operations involve simple addition and subtraction, the order in which the various entries in a statement appear and their relationships often become repetitive and complex. Let’s dive into these numbers for a better understanding.
Revenue Department
The first section, titled Revenue, indicates that Microsoft’s gross (annual) profit, or gross margin, for the fiscal year ending June 30, 2021, was $115.86 billion. It was arrived at by subtracting the cost of revenue ($52.23 billion) from the total revenue ($168.09 billion) the tech giant generated during this fiscal year. Just over 30% of Microsoft’s total sales went to revenue-generating costs, while the corresponding figure for Walmart in fiscal 2021 was around 75% ($429 billion / $572.75 billion). This indicates that Walmart incurred more costs than Microsoft to generate equivalent sales.
Operating Expenses
The next part, called Operating Expenses, takes into account the cost of Microsoft’s revenue ($52.23 billion) and total revenue ($168.09 billion) for the fiscal year to arrive at the aforementioned number. Since Microsoft spent $20.72 billion on research and development and $25.23 billion on SG&A expenses, total operating expenses are calculated by adding all these numbers ($52.23 billion + $20.72 billion + $25.23 billion = $98.18 billion).
Subtracting total operating expenses from total revenue results in operating income (or loss) of $69.92 billion ($168.09 billion – $98.18 billion). This number represents the earnings before interest and taxes (EBIT) of its core business activities and is subsequently used to derive net income.
A comparison of the items shows that Wal-Mart spent almost nothing on research and development and that SG&A and total operating expenses were higher than Microsoft’s.
Income From Continuing Operations
The next section, titled Income from Continuing Operations, calculates net other income or expenses (such as one-time earnings), interest expense, and applicable taxes to arrive at Microsoft’s net income from continuing operations ($61.27 billion). That adds up nearly 60 percent more than Wal-Mart ($13.67 billion).
After making provisions for any non-recurring events, it is possible to arrive at the net income value applicable to common stock. Microsoft’s net income was $61.27 billion, compared to $13.67 billion for Walmart.
Earnings per share is calculated by dividing the net income figure by the weighted average number of shares outstanding. With 7.55 billion shares outstanding to Microsoft, the 2021 EPS comes in at $8.12 per share ($61.27 billion-$7.55 billion). With 2.79 billion shares outstanding in Wal-Mart this fiscal year, earnings per share came in at $4.90 per share (13.67 billion yen; $2.79 billion).
Microsoft had lower earnings-per-share generation costs, higher net income from continuing operations, and higher net income attributable to common stock than Walmart.
Uses of Income Statement
While the main purpose of an income statement is to communicate details of a company’s profitability and business activities to stakeholders, it also provides insight into a company’s internal activities for comparison across various businesses and segments.
Based on the income statement, management can make decisions such as expanding into new geographic areas, advancing sales, increasing productivity, increasing asset utilization or direct sales, or closing a division or product line. Competitors can also use it to gain insight into a company’s success criteria and focus on areas such as increasing research and development spending.
Creditors may find income statements of limited use, because they are more interested in the company’s future cash flows than its past earnings. Research analysts use the income statement to compare year-over-year and quarterly performance. For example, one can assess whether the company’s efforts to reduce cost of sales have helped improve profitability over time, or whether management has kept operating costs under control without compromising profitability.
What are the four main components of the income statement?
(1) Revenue, (2) Expenses, (3) Profit, (4) Loss. The income statement is not a balance sheet or cash flow statement.
What is the difference between operating revenue and non-operating revenue?
Operating revenue is obtained through the core activity of the business, such as selling its products. Non-operating income comes from additional sources such as interest income from the capital held in the bank or income from leasing commercial real estate.
What insights should you look for in the income statement?
The income and expense components can help an investor understand what makes a company profitable (or not). Competitors can use it to measure how their companies compare against various metrics. Research analysts use it to compare performance on a yearly and quarterly basis.
Bottom Line
The income statement provides valuable insight into various aspects of the business. This includes the company’s operations, the performance of its management, potential areas of leakage that reduce profitability, and whether the company is operating in line with peers in the industry.