A company’s financial statements comprise three main statements, one of which is the income statement or statement of profit and loss. The income statement states what a company has earned during the period and what cost it has incurred to generate the earnings. In addition, it shows the expense to finance its operations and the income tax it has to pay on its earnings.
Objective
The objective of the income statement is to provide information about a company’s financial performance over a specified period of time, usually a month, a quarter or a year.
The income statement provides management with an understanding of the financial performance of the company over a specific period of time. With the income statement, management is able to monitor revenue growth, evaluate the cost structure, measure profitability and make strategic decisions. Investors, creditors and other stakeholders may use the income statement to evaluate a company’s profitability and its ability to generate earnings from its operations.
Ratios
There are a number of ratios that are commonly used to assess a company’s financial performance:
- Revenue growth: The rate at which a company’s sales revenue increases over a specific period of time. It is a measure of the company’s ability to generate more revenue from its core business operations. Revenue growth is an important metric because it indicates the company’s ability to increase its market share, expand its customer base and improve profitability
- Gross profit margin: This ratio is calculated by dividing gross profit by total revenue. It measures the percentage of revenue remaining after deducting the cost of goods sold. A higher gross profit margin indicates that a company is generating more profit from revenue.
- Operating profit margin: This ratio is calculated by dividing operating income by total revenue. It measures the percentage of revenue remaining after deducting all operating expenses. A higher operating profit margin indicates that a company is operating more efficiently and generating more profit from its core business activities.
- Net profit margin: This ratio is calculated by dividing net income by total revenue. It measures the percentage of revenue that is left after deducting all expenses, including interest and taxes. A higher net profit margin indicates that a company is generating more profit from all of its business activities.
- Earnings per share (EPS): This ratio is calculated by dividing net income by the number of outstanding shares of common stock. It measures the amount of profit that is attributable to each share of common stock. EPS is a key measure of a company’s profitability and is often used by investors to evaluate the company’s performance.
- Return on equity (ROE): This ratio is calculated by dividing net income by average shareholders’ equity. It measures the rate of return that a company generates on the investment made by its shareholders. ROE is a key measure of a company’s profitability and is often used to compare the performance of different companies in the same industry.
- Price-to-earnings (P/E) ratio: This ratio is calculated by dividing the market price per share of common stock by earnings per share. A higher P/E ratio indicates that investors are willing to pay more for each dollar of earnings, which may indicate that they expect the company to grow and generate higher earnings in the future.
Income statement mechanics
Mathematically, net income is calculated based on:
Net result = (Revenue + Gains) – (Expenses + Losses)
Revenue
Revenue realised through primary activities is often referred to as operating revenue. For a company that manufactures a product, or for a wholesaler, distributor, or retailer involved in the business of selling that product, the revenue from primary activities refers to the revenue earned from the sale of the product. Similarly, for a company engaged in the business of offering services, the revenue from primary activities refers to the revenue or fees earned in exchange for offering those services.
Revenue realised through secondary, non-core business activities is often referred to as non-operating, recurring revenue. This revenue is derived from the earnings that do not arise from the purchase and sale of goods and services and may include income from interest earned on business capital parked in the bank, rental income from business property, income from strategic partnerships like royalty payment receipts, or income from an advertisement display placed on business property.
Revenue should not be confused with receipts. Revenue is usually accounted for in the period in which goods are delivered or services are provided. Receipts are the cash received and are accounted for when the money is received. In many businesses, revenue and receipts do not occur at the same time.
Gains
Gains indicate the net money made from other activities, such as the sale of long-term assets. These include the net income realised from one-time non-business activities, for example a company selling its old transportation van, unused land or a subsidiary company.
Expenses
Every company will incur expenses in order to earn revenue and relate to the day-to-day activities of the company. These include the cost of goods sold (COGS), selling, general, and administrative (SG&A) expenses and depreciation and amortisation. expenses. Typical items on the list are employee wages, sales commissions and expenses for utilities such as electricity and transportation.
Losses
Losses are costs that are incurred as a result of an unexpected event or a non-recurring transaction. Unlike expenses, losses are not part of the normal course of business and are not expected to occur on a regular basis. Examples of losses include write-offs of bad debts, theft or damage to property, and lawsuits or legal settlements.
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Income statement items
The income statement usually comprises the following items:
Revenue
1.400
The income statement starts with the recognition of revenue, which is the amount of money a company earns from the sale of goods or services. Revenue is recognized when it is earned, regardless of when the payment is received.
Cost of goods sold (COGS
-/-650
The cost of goods sold (COGS) is the cost of the materials, labour and overhead expenses associated with producing the goods or services that were sold during the period. COGS is subtracted from revenue to calculate the gross profit.
Gross profit
750
The gross profit is the amount of revenue that is left over after deducting the cost of goods sold.
Operating expenses
-/-400
Operating expenses are all of the expenses associated with running a business, including salaries, rent, utilities, and marketing expenses. Operating expenses are subtracted from the gross profit to calculate operating income.
Operating income (EBIT)
350
Operating income is the amount of money that a company earns from its core business activities, before interest and taxes are deducted.
Interest
-/-150
Interest and taxes are deducted from operating income to calculate net income.
Earning before taxes
200
The earning before tax (EBT) are the basis for the calculation of the income tax
Income taxes
-/-50
The income tax the company has to pay to the tax authorities following their earning before tax.
Net result
150
Net income is the amount of money that a company earns after deducting all of its expenses, including interest and taxes.
Reliability of
The income statement
Given the importance of the income statement, it is essential that the amounts presented are accurate. Ensuring the accuracy of the income statement may involve the following:
- Accurate records: Ensure that all revenues and expenses are recorded accurately in the accounting system and that all supporting documentation is organised and readily accessible. This includes receipts, invoices, bank statements and other relevant documents.
- Follow accounting standards: Adhere to the accounting standards applied by the company to ensure that the income statement is presented accurately and consistently.
- Review for completeness: Ensure that all revenues and expenses are included in the income statement, including any adjustments for accruals, deferrals and estimates.
- Analysis: Analyse trends and variances in revenues and expenses over time and against budget, and investigate any unusual or unexpected fluctuations.
- Conduct periodic audits: Conduct periodic audits by an independent auditor to ensure that the income statement is complete, accurate and free from material misstatements or errors.
- Use internal controls: Implement effective internal controls to prevent errors, fraud or other irregularities from occurring and to detect any issues that arise.
The Fidugius solution and your income statement
The Fidugius Accounting & Reporting Manual is a solution that helps companies to improve the reliability of their balance sheet by providing guidance on how to maintain accurate records through appropriate accounting policies, definition of accounts and accounting treatments. The manual also serves as a training and education resource for new staff members and as a reference for auditors.
