“Income statements are one of the main documents we use to understand a company’s financial health,” says Fanny Cao, a CPA, CGA and Senior Advisor, Financial Products at BDC.
“They show how profitable and sustainable a company is and how efficient its management is. They’re very useful for planning and give you a lot of information on how to improve.”
What is an income statement?
An income statement shows a company’s revenues, expenses and profitability over a period of time. It is also sometimes called a profit-and-loss (P&L) statement or an earnings statement. It shows your:
- revenue from selling products or services
- expenses to generate the revenue and manage your business
- net income (or profit) that remains after your expenses
An income statement is a core component of a company’s financial statements, along with these other statements:
- balance sheet
- cash flow statement
- statement of retained earnings
Income statements may be prepared for different timeframes. Year-end income statements cover the company’s latest fiscal year. Companies may also prepare interim income statements on a monthly, quarterly or semi-annual basis.
Income statements usually give information for both the latest period and at least one prior period to make comparisons easier. For example, an income statement covering January 1 to December 31, 2021, would include the statements for both that year and the previous year—January 1 to December 31, 2020.
Example of an income statement
The example below shows the core components that make up an income statement. Any assumptions made in preparing the income statement are explained in the notes to the financial statements.
| Income statement | ||||
| XYZ Co. | Year one | Year two | ||
| REVENUES | ||||
| Revenue stream 1 | 3,500,000 | 3,700,000 | ||
| Revenue stream 2 | 2,000,000 | 2,250,000 | ||
| Total revenues | 5,500,000 | $500,000 | ||
| COST OF SALES | ||||
| Direct cost 1 | 1,870,000 | 1,270,000 | ||
| Direct cost 2 | 1,402,500 | 1,422,500 | ||
| Total cost of sales | 3,272,500 | 2,692,500 | ||
| GROSS PROFIT | 2,227,500 | 3,257,500 | ||
| Gross margin (% of sales) | 41% | 55% | ||
| SELLING, GENERAL & ADMINISTRATIVE EXPENSES | ||||
| Management and office salaries and benefits | 669,999 | 683,400 | ||
| Advertising and marketing | 135,000 | 255,000 | ||
| Bad debts | 10,000 | - | ||
| Office and general | 75,000 | 100,000 | ||
| Occupancy | 45,000 | 45,000 | ||
| Professional fees | 35,000 | 70,000 | ||
| Insurance | 22,000 | 22,000 | ||
| Repair and maintenance | 17,500 | 23,500 | ||
| Utilities | 5,600 | 5,600 | ||
| Total SG&A expenses | 1,015,099 | 1,204,500 | ||
| OPERATING INCOME | 1,212,401 | 2,053,000 | ||
| INTEREST AND DEPRECIATION | ||||
| Interest | ( 103,900) | ( 93,500) | ||
| Depreciation | ( 145,000) | ( 125,000) | ||
| NON-OPERATING ITEMS | ||||
| Non-operating income | 25,000 | - | ||
| Non-operating expenses | ( 35,000) | ( 56,000) | ||
| EARNINGS BEFORE TAXES | 953,501 | 1,778,500 | ||
| INCOME TAXES | 31,250 | 31,250 | ||
| NET INCOME | 922,251 | 1,747,250 | ||
You can download a free income statement template here.
What are the main parts of an income statement?
Here are the main elements of an income statement:
1) Revenue
Also known as sales, revenue is the amount of money a company has earned by selling its products and services in the period. The revenue amount includes only money made from core activites of the business—those related to its primary operations.
For example, if a company manufactures industrial machines, its revenue would include earnings from that activity. It wouldn’t include money earned from selling a building or financial investments. These are recorded elsewhere in the income statement.
2) Cost of goods sold/cost of sales
The cost of goods sold (for manufacturing companies) or cost of sales (for retailers and wholesalers) is all the direct costs associated with making or acquiring the company’s products and/or offering its services. The amount typically includes raw materials and labour along with amortization expenses. It doesn’t include indirect costs, such as administration, marketing, sales or distribution.
3) Gross profit
Gross profit (sometimes called gross margin or contribution margin) is revenue minus cost of goods sold/cost of sales.
Gross profit is used to calculate the gross profit margin, a commonly used profitability measure. This metric is often used as an indicator of a company’s efficiency and can be benchmarked against industry peers.
4) Operating expenses
Operating expenses (also called selling, general and administrative expenses, or SG&A) are the indirect costs of running the business. These may include:
- rent and utilities
- marketing and advertising
- insurance
- office supplies
- maintenance and repairs
- employee benefits
- accounting and legal fees
- property taxes
5) Operating income
Operating income is what is left over after operating expenses are subtracted from gross profit.
6) Non-operating items
Non-operating items are gains and losses from non-core activities. Examples may include:
- interest
- dividends
- one-time items such as asset sale earnings or relocation costs
7) Earnings before taxes (EBT)
Earnings before taxes (also called income before taxes) is the amount of money left after all expenses and losses are subtracted from all revenue and gains. EBT is often used as a profitability indicator because companies pay taxes at different rates depending on their location.
8) Net income
Net income (aka net profit) is the amount left over after income taxes are subtracted from EBT. It is used to calculate other useful measures, such as:
- net profit margin, a widely used profitability indicator of that can be benchmarked against industry peers
- EBITDA (earnings before interest, taxes, depreciation and amortization)
How do you analyze an income statement?
An income statement can be analyzed in several ways:
1) Bottom line
Look at net income to see if the company makes a profit and how the amount of profit has changed from year to year. For a better comparison, you can also calculate and compare the net profit margin. Review possible reasons for changes in your net profit and net profit margin.
“Maybe you’re making more money, but your profit margin is lower,” Cao says. “Why is that? The income statement allows you to do a lot of analysis. Maybe you have a net loss, but it’s because of a nonrecurring expense. It’s not as simple as revenue and profit. It’s also everything in between.”
2) Vertical analysis
Starting with cost of goods sold/cost of sales and working your way down, calculate each line item as a portion of revenue. This allows you to see how much various expenses affect your profitability and zero in on areas for potential improvement.
3) Time series analysis
Compare each line item with previous years both in raw dollar terms and as a portion of revenue. This allows you to understand why your profitability may have changed and think about how to improve.
4) Notes to the financial statements
Closely review the notes to the financial statements. This important section of most accountant-prepared financial statements discloses assumptions made in preparing the income statement and other information key to interpreting and analyzing the numbers.
“The notes are really integral to understanding the data correctly,” Cao says. “They reflect the quality of the statement.”
What are the uses of an income statement?
Income statements are a key document for managing and building your business and working with bankers, investors and other partners.
- Income statements are important for strategic planning, budgeting and financial forecasts. You can use interim and annual income statements to see how your business is performing through the year and at year-end, quickly identify problem areas and compare finances with targets, budgets and projections.
- Income statements are used by lenders, investors and other partners along with your financial statements to understand the business and its health.
- Income statements are used to assess annual tax filings.
What is the difference between an income statement and a profit-and-loss statement?
The income statement and a profit-and-loss statement are the same thing.
What is the difference between an income statement and a balance sheet?
A balance sheet shows what a business owns and how much it owes at a specific point in time. An income statement shows what a company earned and spent over a period of time.
What is a statement of comprehensive income?
In addition to an income statement, some businesses also prepare a statement of comprehensive income. This reports revenues and expenses that haven’t yet been realized. These could include unrealized gains or losses from:
- financial investments
- foreign currency adjustments
- pension liabilities
Learn more by downloading our free guide for entrepreneurs Understand Your Financial Statements: A Financial Management Guide for Entrepreneurs.
