The income statement
The income statement shows whether a business earned a profit over a period. It is often the first statement investors read.
Purpose
The income statement (also called the statement of operations or profit and loss statement) reports revenues and expenses for a period, such as a quarter or year, and the resulting net income or net loss. It measures performance over time, unlike the balance sheet, which is a snapshot.
Single-step format
A single-step income statement lists all revenues together and all expenses together, subtracting total expenses from total revenues to find net income. It is simple and common for small service businesses.
Multi-step format
A multi-step income statement shows several subtotals: net sales minus cost of goods sold equals gross profit; gross profit minus operating expenses equals operating income; adding or subtracting non-operating items (such as interest) gives income before taxes; subtracting income tax expense gives net income.
Key lines
Net sales are gross sales minus returns, allowances, and discounts. Cost of goods sold (COGS) is the cost of the products sold. Operating expenses include selling expenses (advertising, sales salaries) and administrative expenses (office salaries, rent). Non-operating items include interest income and expense and gains or losses on selling assets.
Earnings per share
Corporations report earnings per share (EPS): net income available to common shareholders divided by the weighted average number of common shares outstanding. EPS is widely followed by investors and analysts; the price-to-earnings (P/E) ratio compares the share price with EPS.
Comprehensive income
Some gains and losses, such as certain unrealised gains on investments and foreign currency translation adjustments, bypass net income and are reported in other comprehensive income. Comprehensive income equals net income plus other comprehensive income.
Reading an income statement
Analysts look at trends in revenue growth, gross margin (gross profit / net sales), operating margin, and net margin, and compare with competitors. A business with rising revenue but falling margins may be cutting prices or facing rising costs.
Worked example
A retailer has net sales of 900,000 dollars, COGS of 540,000, selling expenses of 150,000, administrative expenses of 100,000, interest expense of 20,000, and income tax of 18,000. Gross profit = 360,000; operating income = 110,000; income before taxes = 90,000; net income = 72,000. Gross margin is 40% and net margin 8%.
Key takeaways
The income statement reports revenues, expenses, and net income for a period. Single-step formats group revenues and expenses; multi-step formats show gross profit, operating income, and income before taxes. Net sales subtract returns and discounts; COGS is the cost of products sold. Corporations report EPS, used in P/E ratios. Other comprehensive income captures certain gains and losses. Margins and trends reveal performance.
Flashcard
Revenues, expenses, net income over a period
Check your understanding
Net sales are 400,000 and cost of goods sold is 250,000. What is gross profit?