Reading the Income Statement

The company’s profit and loss

The income statement used to be known as the profit and loss statement, and this statement can also be referred as an operations statement.

The income statement shows all of the company’s revenues and expenses for each accounting period. The most common accounting periods are quarterly for the first three quarters and then one final annual report.

Thus the income statement sheet provides a snapshot of the company’s profitability, with the first three quarterly reports accounting for a three month period and the final annual report accounting for the full year. The financial data taken from the income statement and from the balance sheet statement are used to evaluate a company’s financial position and its risk of bankruptcy.

The income statement is divided into several items as follows.

Net Sales

Net sales are also referred to as revenue. This item may be shown as a single line, or may be shown with several lines which include Gross Sales, Returns and then Net Sales.

Revenue is extremely important, as a company can only grow as fast as its revenue grows in the long run.

Cost of Sales

Cost of sales includes all costs that are directly attributed to obtaining the above revenue. It includes any costs directly incurred in manufacturing such as materials and labor, and any costs directly incurred in selling the products such as sales staff salaries and commissions.

Cost of sales excludes any expenditure such as rent or utility bills. These are classified as expenses and reported separately.

The cost of sales is usually shown with several items on the income statement.

Gross Income

Gross income or gross profit as it is often referred to as, is the Net Sales less the Cost of Sales.

General, Selling and Administrative Expenses

This item includes the company’s operational expenses. This is the item where all the other expenses are included. These were the expenditures that could not be included in the direct cost of sales item, such as rent and utility bills.

Operating Income

Operating income is the profit that’s left after the General, Selling and Administrative Expenses are deducted from the Gross profit. This profit figure represents the company’s profitability in performing its core business function. This does exclude any non-operating expenditure such as interest payments on borrowed money.

Other Income and Other Expenses

This is where any interest expenses are included and any interest payments received. Also included here is any profit or loss from foreign currency exchanges.

Pretax Income

The pretax income or pretax profit as it is often referred to, is the operating profit less the net result of the Other Income and Other Expenses item.

Income Taxes

This item includes the tax liabilities incurred on the company’s Profit. This income tax amount has not actually been paid yet, but is accounted for here in this period and it is an expense that must be paid.

Net Income

This item is the profit that is left after the income tax liability has been deducted from the pretax profit. This figure represents the actual profit that the company made and is often referred to as the bottom line. The Net Income is also referred to as the Net Profit. If this figure is negative, it means that the company made a loss and thus now has less money than what it had a period ago.

Income Statement

After the company pays a dividend if any, the remaining net income is then referred to as retained earnings and becomes part of the shareholders’ equity on the balance sheet statement.

For an annual statement, the income statement shows the current fiscal year along side the previous fiscal year for comparative purposes. For a quarterly statement, the income statement shows the current period along side the previous corresponding period (which is the same quarter a year ago).

An example of a simplified income statement outlining the main items is shown below in Table 1.

Table 1. Example of a simplified income statement

Net Sales73,00070,00065,000
Cost of Sales50,00048,00045,000
Gross Income23,00022,00020,000
General and Administrative Costs4,0004,0004,000
Operating Income19,00018,00016,000
Other Income1,0001,0001,000
Pretax Income20,00019,00017,000
Income Taxes4,0004,0004,000
Net Income16,00015,00013,000

A company’s actual income statement will have more items listed for most categories than the simplified example given above. The amount and the type of items listed vary from company to company and between industries. However, the basic format of listing the categories remains consistent between company reports.