Understanding Income Statement In Detail
The income statement, which is also known as the profit and loss statement and the statement of operations, summarizes the revenues and expenses incurred by the business and can be used to evaluate its overall financial performance during a period.
What is the Income Statement?
The Income Statement is one of a company's key financial statements that shows its profit and loss over time. Profit or loss is calculated by adding all revenues and deducting all expenses from both operating and non-operating activities.
One of three statements used in corporate finance (including financial modelling) and accounting is the income statement. The statement clearly and logically displays the company's revenue, costs, gross profit, selling and administrative expenses, other expenses and income, taxes paid, and net profit.
The statement is divided into time periods that correspond to the company's operations logically. The most common periodic division is monthly (for internal reporting), but some businesses may use a thirteen-period cycle. These periodic statements are totaled to produce quarterly and annual results.
Components Of Income Statement
Revenue is how much businesses charge customers for goods and services. It's the sum of the price and the number of things sold. In the income statement, it's usually the first thing you see. It's also called the "top line."
Furthermore, it is important to know that the revenue on the income statement may not be the same as the cash that was actually paid out. It will either get paid in cash or on credit after a company sells or gives away its product or service. While the revenue must be shown on the income statement right away, which is called the revenue recognition principle, it won't be shown on the cash flow statement until the payment has been made.
Some companies even split their revenue so that investors can see which products and countries are making the company the most money, which helps them make money.
Costs Of Goods Sold (“COGS”)
The costs of goods sold, abbreviated "COGS," are primarily expenses that are directly related to the production of a product and are not included in the price of the product. Among those are, among others, the following:
costs of raw materials, costs of storing raw materials and finished goods, direct labour costs for employees who produce the goods, and other overhead costs are all included.
The difference between revenues and costs of goods sold is referred to as the gross profit. It essentially displays the net value of revenues after deducting the cost of goods sold (COGS).
The gross profit margin, which is defined as the ratio of gross profit to revenues, is a common metric used to compare companies.
Gross Profit = Revenues – COGS Gross Margin = Gross Profit / Revenues
Operating expenses (also known as "OpEx") are primarily indirect expenses that a company incurs as a result of carrying out its regular business operations. It should not be confused with capital expenditure (also known as "CapEx"), which is the amount of money spent on the purchase, maintenance, or enhancement of assets.
Consider the following illustration: When a company purchases a car, the purchase price is deducted from the company's profit as a capital expenditure. The costs of operating the car, such as gas and insurance, are referred to as operating expenses.
Furthermore, rather than reporting a lump sum of operating expenses, companies are more likely to report the following subcategories of operating expenses on their income statement:
Selling, general, and administrative expenses ("SG&A"), which include, among other things, selling costs, salaries, and warehousing, are a type of operating expense. For more information, see Research and development ("R&D"), which are the expenses incurred as a result of the development of new goods and services. Marketing expenses, which include marketing research costs, promotions, and advertising, are included in this category.
These subcategories are further subdivided into line items on comprehensive income statements, which are even more specific. The more detailed a company's financial statements are, the more conclusions an analyst can draw when evaluating the company.
Other Operating Income
Companies can generate income from operations that are not directly related to their primary business. Due to the fact that these income streams are considered non-core, they are not included in the revenue statement. They do, however, contribute to taxable income and, as a result, must be included on the income statement.
To give you an example, consider a company that owns a commercial property. However, they are unable to fill all of the vacant spaces on their own and have therefore decided to lease some of the offices to other businesses. In this case, the rental income generated would be considered non-core and would appear on the income statement as other operating income.
Another example would be a retailer who specializes in the sale of high-end electronic goods. They provide a vendor loan in order to encourage more customers to purchase their products. In order to repay the vendor loan, it must be paid back in monthly instalments over a specified period of time, plus interest. In that case, the interest payments made to the company are included in the calculation of additional income.
For earnings before interest, taxes, depreciation and amortization (EBITDA), look up earnings before interest, taxes, depreciation and amortization. It is considered to be an important, if not the most important, financial metric by analysts and investors. But why is this the case?
The operating profit of a company is represented by EBITDA. The figure does not include, however, certain costs that may differ from one company to another due to differences in tax regulations, depreciation and amortization methods, as well as different financing structures.
Consider the following scenario: we are comparing two businesses that have the same operations, revenues, and operating costs, but are located in two different countries. One company is based in Australia and is subject to a corporate income tax of 30%, whereas the other company is based in Singapore and is subject to a corporate income tax of only 17%. If an analyst were to compare the two companies on the basis of net income, the company in Singapore would appear to be significantly more profitable as a result of lower taxes and, consequently, higher net income.
The same is true for depreciation and the structure of the financial institution. While different depreciation methods in different tax jurisdictions result in different taxable incomes, different financing structures are responsible for different costs of capital across those jurisdictions.
To bring this discussion to a close, it should be noted that companies typically exclude "one-time" items from their EBIT. These expenses or revenues represent a one-time occurrence that is not expected to recur in the future. As a result, although they should not be included in operating profit (EBIT), they are included in net income due to their nature.
Finally, it is the analyst's responsibility to bring the companies into a comparable position. That essentially means comparing apples to apples, and EBITDA is the very apple in the equation that represents this exact comparison. As a result, EBITDA is frequently used in the valuation of a company's operations.
Depreciation & Amortization
Physical assets are written off over the course of their useful lives, which is known as depreciation in accounting terms. Tangible assets include, among other things, real estate, equipment, vehicles, and information technology.
Consider the following illustration. A car is purchased by a company for $100. The vehicle has a useful life of ten years, and the company is using the straight-line method to calculate the cost of ownership. A car is written off for 10 percent (1 of ten years) of the initial purchase price after one year, and the company incurs depreciation costs of $10 on their income statement as a result of this. Instead of recognizing the cost of $100 in a single year, the company must capitalize the cost on its balance sheet and then spread the costs over the asset's useful life in order to be compliant.
Amortization and depreciation are very similar concepts. Intangible assets such as trademarks, patents, and copyrights are included in this category and are therefore subject to write-off.
Not all assets are eligible for depreciation or amortization. The depreciation of land, for example, is usually exempt from depreciation because its useful life is not deemed to be limited.
Note: Because depreciation is a nature of expense, it is often spread across multiple functions, and as a result, most income statements will not directly disclose depreciation and amortization (D&A). However, because EBITDA is a critical metric for investors, it is frequently disclosed in a note to the income statement in addition to the income statement.
Earnings before interest and taxes, abbreviated as "EBIT," are calculated by subtracting depreciation and amortization costs from earnings before interest and taxes (EBITDA).
While companies that operate under an asset-light business model will only experience a minor difference between EBITDA and EBIT, depreciation costs for other businesses may have a more significant impact on EBIT than for asset-light businesses.
EBIT is used in the same way as EBITDA in the valuation process, and analysts will calculate an EBIT margin to compare companies of different sizes to one another.
Net Interest Income
Net interest, which is sometimes referred to as net interest income or "NII," is the difference between interest income and interest expense in a financial statement.
It is the income earned on cash held in savings accounts, money market funds, deposits, and other investments that is referred to as interest income. Interest expense refers to the amount of interest that must be paid on debt that the company has borrowed.
EBT is an for earnings before taxes. It is referred to as pre-tax profit in some circles. As with EBITDA and EBIT, it does not take into account the impact of taxes on the company's performance, but it does include the impact of depreciation and amortization (D&A) and interest.
Corporate taxes are financial charges that must be paid by a company in order for it to continue operating. The pre-tax profit of a corporation is subject to corporate income tax (EBT).
It is critical to understand that different tax jurisdictions may impose different rates on corporate income taxation. Federal levels, i.e. between countries, can be affected, as can state-level levels, as can a state-level level.
The bottom line of every income statement is referred to as net income. Net income is also referred to as net earnings or net profit in some circles.
In the case of publicly traded companies, net income is used to calculate earnings per share ("EPS"). Furthermore, it serves as the foundation for potential dividend payments.
Furthermore, net income is the first line item on the cash flow statement, which is a good thing. As a result of the distribution of dividends, the remaining portion of net income is deposited in the company's retained earnings on the balance sheet.