What to know about the income statement: an important financial document that shows the income and expenses of a business
- An income statement is a financial document that details the income and expenses of a business.
- Some investors and analysts use income statements to make investment decisions.
- The income statement as well as additional financial documents must be filed with the Securities and Exchange Commission (SEC).
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An income statement tells you whether or not a business made a profit or a loss during the reporting period. It is one of the three main financial statements used to assess the health of a business along with the balance sheet and cash flow statement.
The income statement, sometimes simply referred to as the income statement or simply “P&L” begins with the amount of money the business has earned and deducts expenses made during the reporting period ending in net profit or loss. clear. “Income statements are important because they can show how well a business is run and can provide historical data to develop trends to help a business perform better,” says Camari Ellis, EA, former portfolio manager and founder of The Philly Tax Team.
Understand how income statements work
The income statement is important to the different parties. Investors can use income statements, along with other financial statements, to make investment decisions and determine the financial health of a business. “The income statement should be used by anyone trying to understand the business being done as well as the profitability of a company,” says Patrick Badolato, PhD, CPA and senior lecturer in the accounting department at the McCombs School of Business.
An increasing amount of sales year over year can be attractive to a potential investor and can be found in the first line of an income statement. Conversely, if costs go up, this can also be seen on the income statement and may cause an investor to ask more questions about the long-term profitability of the business. Investors and financial analysts also use the income statement to derive popular financial ratios such as earnings per share (EPS).
Earnings per share is a measure that compares a company’s net income against shares outstanding. Another commonly used metric that takes into account the company’s stock price relative to EPS is the price-to-earnings ratio, or P / E ratio. When comparing companies, EPS and P / E ratio can help differentiate two companies in the same category and help an investor make a smarter investment decision, but both use the information provided in the account. results.
“The equation that governs the income statement is: income – expenses + gains – losses = net profit”, says Patrick Badolato, PhD, CPA
Income statements are also important for regulators. All public companies are required to file a Form 10-K each year with the SEC and a Form 10-Q each quarter, which include the income statement and other financial documents and information.
The income statement is broken down into several key elements to help understand how the business manages its income.
- Revenue: This is the amount of money the business brought in during the reporting period. With revenue, it can be important to note any trends to determine if the business is making more money over time or if sales are slowing down.
- Expenses: This line details how much the business spent. As with revenue, it can be important to note trends to see if the business is spending more or if it becomes more efficient over time. When we look at spending, “We need to determine whether the spending grows in proportion to income and the drivers of that spending,” says Badolato.
- Cost of Goods Sold (COGS): amount spent on the production of the goods or services sold. For a company like Apple, that would include the glass to make the phone screen or the chips that go into the iPhone.
- Gross Profit: This is the amount of money earned minus the cost of goods sold. This will usually be calculated on the income statement by subtracting revenue minus cost of goods sold.
- Operating and non-operating costs: Operating costs are the cost of bringing the product to market. This could include things like marketing, payroll, and overhead, like insurance and rent. Non-operational expenses may include items that are not directly related to core business functions. This can include items such as contributions to pension plans or dividends to shareholders.
- Income before taxes: This is the total income before accounting for taxes paid.
- Depreciation: This is an accounting measure to recognize the cost of the impairment of the tangible assets of the business.
- Profit before interest, taxes, depreciation and amortization (EBITDA): This is a measure that is sometimes used in place of net income to assess the profitability of a business.
- Net income: Net income (or loss) is known as the company’s bottom line because of its position in the income statement. Simply put, it is the money the business has made or lost.
Analysis of the income statement
When analyzing income statements, two main methods are used: vertical analysis and horizontal analysis.
Vertical analysis shows each item on a financial statement as a percentage. An example of this would be the CIGS expressed as 35% of total income. This type of analysis can be useful when comparing with other companies in the industry.
Horizontal analysis is used to examine a business’s performance over two or more time periods by stacking each row item directly next to each other from the previous period. Instead of looking at one income statement at a time for different time periods, horizontal analysis compares them side by side in a single view.
How to read an income statement
Below is Ford’s 2021 quarterly income statement of Form 10-Q. One of the first things you’ll notice is that the report uses horizontal analysis. Indeed, the report compares the second quarter of 2020 with the second quarter of 2021 as well as the first half of 2020 and the first half of 2021.
In the first section under Income, you’ll see each of Ford’s major revenue streams, including car sales under Automotive, Ford Credit, and Mobility. In the notes section of the 10-Q, the Mobility line refers to Ford’s autonomous vehicles and related activities, as well as its stake in Argo AI.
Then in the Cost and expenses section, you will notice where Ford is spending its money. The bulk of these expenses fall under cost of sales, which is another name for cost of goods sold. You can also see costs increased from the second quarter of 2020 to the second quarter of 2021, resulting in net income of $ 561 million in the second quarter and $ 3.8 billion in the first half of 2021. in the last column on the right.
Income statement vs balance sheet
Income statements and balance sheets provide important details about how a business uses its cash and other assets, but there are a few key differences between the two. Think of an income statement as a financial timeline, whereas a balance sheet is a snapshot at a point in time. This is because income statements provide details on the amount of money earned and spent during a period. The income statement essentially answers the following questions: How much money has the company made? How was this money spent? Did the company make a profit?
The balance sheet, on the other hand, tells you how much the business has in assets, liabilities and equity. The balance sheet follows a simple formula:
Assets = Liabilities + Equity
As the name suggests, the balance sheet numbers must match because any increase or decrease must be offset. Unlike the income statement, it does not provide information on the amount of money the business has earned or lost, it only provides the amount of debt, cash and other assets that the business owns. at this moment.
Although these financial statements are different, the income statement and the balance sheet as well as the cash flow statement are still related and should be used together to determine a more holistic financial picture of a business.
|Income statement||Balance sheet|
The financial report
The income statement is a good entry point to understand and assess the income and costs of a business, but it is important to keep in mind that it is not a document that can tell all the story. “Financial statements are designed to function as a system and not as stand-alone statements,” Badolato adds. “The income statement is just one part of understanding a company’s financial performance. Using a financial statement without the others and other publicly available information – such as footnotes in a financial record – would be similar to betting before looking at your cards. “