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What is an Income Statement?

Kathleen ChaykowskiApril 29, 2020
Covered finance and business at Forbes and The Wall Street Journal. BA, Stanford University.
definition

An income statement is one of the key three financial statements (along with the balance sheet and cash flow statement) which highlights how much profit a company has generated over a set period of time, and helps investors analyze the financial performance of a company.

This is for illustrative purposes only, to show the basic makeup of an income statement. A company’s income statement may contain more items than the ones shown above.

🤔 Understanding an income statement

An income statement is one of the most widely cited financial statements. While the balance sheet is a like a snapshot of a company taken at any point in time, an income statement reflects a specific duration of time, whether it’s a quarter or a full year. It’s focused on profit, which is calculated by subtracting expenses from revenue (how much money a company is making, from any and all sources). A company’s ability to turn a profit (or not) is an important piece of information for anyone trying to gauge the performance and future potential of a company, whether that’s investors, analysts, lenders, creditors, competitors, or regulators. The income statement is also known as the statement of revenue and expense and the profit and loss statement.

example

For a real-world example, let’s look at a summarized version of Amazon’s income statement for the full year of 2018. We start with revenue and deduct expenses such as the cost of selling goods and services, to calculate a company’s profit:

  • Revenue: $232.9B
  • Cost of goods sold (expenses associated with producing and selling a product): -$139.2B
  • Selling, General & Administrative expenses (such as wages and office rent): -$81B
  • Interest expense (interest paid on borrowings like bonds, loans, or credit): -$1.4B
  • Income tax: -$1.2B
  • = Net income: $10.1B

Takeaway

An income statement is kind of like a video reel...

It calculates a company’s net profit, by adding total revenue and subtracting total costs over a specific period of time. It’s one of the most widely cited financial statements, and helps shed light on a company’s profitability (how much profit or sales it generates in relation to what it spends) and how it operates (its biggest costs).

Income Statement Illo

Tell me more...

What is the structure of an income statement?
How can an income statement be useful?
What are net profit, net income, and net earnings?
What are revenues vs. gains?
What are costs vs. losses?
What’s the difference between a balance statement and an income statement?
What’s the difference between a statement of cash flows and an income statement?

What is the structure of an income statement?

An income statement is one of three main types of financial statements, alongside the balance sheet and the cash flow statement, that can help analysts and investors better understand the financial health and potential of a company. The income statement in particular, is focused most on calculating a company’s revenues and expenses (its costs), to ultimately calculate its profit (how much it’s really making). For this reason, the income statement is also called the profit and loss statement, or the statement of revenue and expense.

While the balance sheet helps capture a company’s financial position at any given snapshot in time, the income statement is built to report a company’s income or profit over a specific financial period of time, whether that’s a year or a single quarter.

The four key parts of the income statement, are revenue, gains, costs, and losses. The revenue and costs are the primary part of the income statement — they’re part of the recurring or operating elements of the company. The gains and losses represent separate investments by the company, and are typically just a fraction of the income statement — they’re part of the non-operating or non-recurring elements of the company.

Net income = (Revenue + Gains) - (Expenses + Losses)

The gist is that the income statement calculates a company’s net income (its profit or loss, which is also called net earnings). That net income can then be broken down to determine earnings per share, or EPS, which helps investors further evaluate a stock.

How can an income statement be useful?

Income statements and the earnings per share (EPS) metric can be powerful tools for evaluating a company’s performance, biggest costs, and how efficiently it’s able to operate. At the purest level, it’s a standardized way of being able to determine how much a company is making (in which case it’s operating at a profit) or losing (when it’s operating at a loss).

They are standard components of public company’s publicly disclosed earnings statements. Depending on how they change over time, this information can significantly affect the way analysts rate a particular stock, as well as how that stock trades on the market. This is particularly true on a quarterly basis, when earnings are released. It’s also standard for private companies to produce income statements, however, they are typically not required to file them publicly.

Income statements aren’t only helpful for analysts and investors — they’re also often used by the management of a company to help identify key trends. For example, which lines of a business are most profitable or aren’t? Have there been fluctuations in costs? And which initiatives are translating into higher profit?

Income statements are also useful to creditors and lenders like banks, which want to know if the entity they’re lending money to can actually pay them back. Banks may analyze income statements before deciding whether or not to make a loan to a company, and they can also use them if they’re considering reigning in a line of credit.

What are net profit, net income, and net earnings?

These are all names for the same thing. Net profit is what’s more colloquially known as the “bottom line” — it’s a measure of the profitability of a company after accounting for all costs and taxes.

In the case of an income statement, net profit or net income is calculated by taking the difference between the total of revenues and gains, and the total of expenses and losses (including interest payments and taxes). What’s left is what the company can actually hold on to, without any obligation to pay it to shareholders or to a client.

What are revenues vs. gains?

Revenue and gains both refer to how much money is generated by a business. However, revenue tends to refer to money that comes in from a business’s core revenue streams and is one of the top items in an income statement because it’s part of the operations and is recurring. Gains may be the result of a one-time sale (like selling off a real estate investment) that’s a non-operational or non-recurring benefit to the company. Because a capital gain like this is less core to the business, it occurs lower down in the income statement as non-operating income.

What are costs vs. losses?

Costs are what’s spent by the business in order to function. Some of the main types of costs you’ll come across are the “cost of goods sold” (the direct costs associated with producing goods sold) or “selling, general and administrative expenses” (which is known as SG&A, and refers to all of the costs not directly tied to producing a product or service). Similar to revenues, these are a core part of the operating and recurring elements of a company, so they appear toward the top of the income statement.

Losses are typically less frequent, inconsistent, one-off items, like the loss taken on a sale of a long-term piece of equipment for less than its purchase price. Similar to gains, losses reflect business events that aren’t core to the business, so are placed in the non-operating or non-recurring portion of the income statement toward the bottom.

What’s the difference between a balance statement and an income statement?

A balance sheet is a snapshot of a company’s financial position at any given point in time, while an income statement spells out how much profit (or loss) a company is generating over a specific period of time, often a financial quarter or a full year. They’re both some of the most widely used financial statements that help illuminate the performance of a company, but their components are different.

The balance sheet represents an equation that shows that a company’s assets (what the company owns) are equal to its liabilities (what it owes) plus shareholders’ equity (the value of shareholders’ equity, should that company shut down, sell its assets, or pay its debts).

Meanwhile, the income statement is all about profit. It calculates profit by taking the difference of (revenues + gains) - (expenses + losses), and it also shows the impact of interest and tax costs, along with depreciation.

What’s the difference between a statement of cash flows and an income statement?

While the income statement is all about understanding a company’s profit (revenue - expenses), the cash flow statement is all about understanding the cash going into and out of a company. For example, cash going into a company could come from sales or capital from investors, while cash flowing out of a company could reflect payment for expenses over a specific financial period.

There are three parts to a cash flow statement:

  1. Cash flow from operations: This is all of the cash a business makes from operations (net income or losses).
  2. Cash flow from investment: This represents the cash flowing into or out of a company as a result of gains or losses in the company’s investments (a piece of machinery, a building, investment securities).
  3. Cash flow from financing: This is an overview of cash from all financing activities. Typical sources of cash flow include cash raised by selling stocks and bonds or borrowing from banks. Likewise, paying back a bank loan would show up as a use of cash flow.

Together, the income statement, balance sheet, and cash flow statement are three of the main financial statements analysts and investors examine to better understand the performance and potential of a company.

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