Ask any company, business owner, or investor about income statements and they will tell you how important this document is. Other financial documents used alongside the income statement are the balance sheet and the Cash Flow statement.
- What is an income statement and what is it used for?
- Why is the income statement important?
- Income statement terms
- Earnings per Share or EPS
- Must a publicly-traded company prepare income statements?
What is an income statement and what is it used for?
An income statement is a financial document or report that details a company’s earnings/revenues and expenses over a specific period in the fiscal year. Companies use the income statement to calculate net income, a key component when it comes to taxation.
It can be done monthly, quarterly, or annually and is sometimes referred to as a profit and loss statement.
Parts of an income statement
An income statement contains a company’s income and expenses and has two sections:
- operating section
- non-operating section
The operating section contains details of revenue and expenses e.g. cost of production and sales.
Why is the income statement important?
Businesses need to have income statements as they help the company as well as its investor.
They provide important financial information that anyone can use to establish the company’s financial health, especially its profitability.
Investors use income statements as a financial reporting tool, which combined with the above information, helps the investors make key investment decisions.
For bankers and vendors, the loss and profit statement provides vital financial information necessary to help them determine credit limits.
These statements can also form the basis for financial forecasting.
Most big companies use income statements to reorganize and strategize by eliminating performing poorly revenue channels and enhancing the most productive ones. Additionally, they use these statements to back up their proposals when seeking partnerships and funding.
Income statement key terms
To have a better understanding of income statements, one needs to grasp the key terminology used in these documents. We call these components of income statements and they include:
We can also refer to them as sales. This is the company’s revenue which is received from sales or services and it is always displayed at the very top of the statement.
Different types of businesses have different types of revenue channels.
Cost of Goods Sold (COGS)
It is also referred to as “cost-of-sales” when the company is a service business. It aggregates with the direct cost which is associated with selling products to generate revenue. Examples of direct costs include labor, materials, and allocation of other expenses.
This is calculated by subtracting the cost of goods sold from sales revenue.
Marketing, Advertising and Promotion expenses
All expenses related to selling.
General and Administrative Expenses (G&A)
A section that contains all other indirect expenses associated with running the business. For example salaries and wages, rent and office expenses, insurance, travel expenses, and sometimes depreciation and amortization, along with other operational expenses.
Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) is calculated by subtracting selling general and administrative expenses “SG&A” (excluding amortization and depreciation) from the gross profit.
Depreciation and Amortization Expense
All these are non-cash expenses that are created by accountants to allow them to spread out the cost of capital assets, for example, property, plant, and equipment (PP&E).
Operating Income (EBIT)
This is the profit before any non-operating income, non-operating expenses, interest, or taxes are subtracted from revenues
Interest expense and interest income put as separate line items in the income statement. It’s also determined by the debt schedule.
Pre-tax income or EBT
Earnings before Tax (EBT) or pre-tax income is calculated by subtracting interest expense from operating income. It is the final subtotal before arriving at net income.
All relevant taxes charged on pre-tax income. The total tax expense can consist of both current taxes and future taxes.
Earnings per Share or EPS
Income statements will also have an input for earnings per share or EPS. It is a calculation that shows the amount of money each shareholder is set to receive per share held in the company’s stock. The EPS is determined by dividing the company’s net income at that given period by the outstanding shares.
Must a publicly traded company prepare income statements?
Every publicly traded company must prepare and provide an income statement. These documents are used together with others, including balance sheets and cash flow statements. A publicly traded company must ensure its income statements are available to the general public whenever needed.
The making of an income statement
Creating income statements to report the profits or losses that a business has been making is a process that should not be taken lightly. The business owner needs to know all the data to include in the document. If a business has not kept its records appropriately, it may be a challenge, but it will be more comfortable when there are electronic copies.
In addition to that, one may want to get an automated income statement if they have the right tools. Nonetheless, whether one is an expert or a total novice in business, one can use the following steps to come up with statements that reflect the real performance of their business.
Choose the statement period
To prepare an income statement, business owners should start by identifying the period over which they will be reporting their sales activities. Although they may be at liberty to choose their period, some regulations may require specific periods.
For instance, when doing it for personal use, there are no restrictions as one can choose to calculate it over one month or any other period. However, most government agencies require statements to be calculated annually. In some situations, quarterly reports may be required. Defining the period helps in capturing the right data.
Calculate your revenue
What does an income statement tell you? One should know how much has been generated by looking at the report. It indicates it is essential to start with the revenue. Calculating the amount of money that every income channel has been bringing in may take time, but it should be done carefully.
Because of that, it may be useful to start by listing all the income channels and following up on their income throughout the reporting period. Some income statement components also break down the specific sales that brought in the revenue through that channel. Therefore, it will be easy to come up with the total business revenue.
Calculate all expenses
If a business owner cannot calculate all expenses in a reporting period, why have an income statement? A sales revenue income statement should detail all costs, especially the operational ones because they show where most of the generated revenue goes.
Additionally, a big company income statement may differ from that of a small business because the kinds of expenses vary. To avoid confusion, one is supposed to record the costs in a different document every time they incur them. It helps to retrieve them easily when they are needed for this purpose.
When it comes to how to make an income statement, a business owner should look for the right tools.
Digital business tools are the best for this purpose. Some can capture such data on an ongoing basis so that they will generate an automated record at the click of a button.
It may also help when income statement templates are used because they only require one to enter data in designated fields, and because of that, coming up with total revenue and expenditures should not be a difficult task.
The purpose of an income statement is to show how much profit or loss a company has made during a certain period. The income statement is important because it shows the profitability of a company during a specified time interval. Though it shows revenues, expenses, gains, and losses it does not show cash received or cash paid out.