The Income Statement shows the revenues, expenses, and profits (or losses) of an entity over a specified period of time. In other words, it is a description of the entities profitability over a period of time (usually quarterly or annually).
Income Statement Components
Revenue is the money an entity receives from the sale of goods or services. Other terms frequently used for revenue are sales, net sales, or sale revenue. It is also referred to as the “top line” because revenues are reported at the top of the income statement.
Cost of Goods Sold
Cost of goods sold are the direct costs of producing the goods being offered by the entity. This would include the materials, labor, and other resources required for production.
Gross profit is the difference between the revenue received for the product less the cost of goods sold.
Operating expenses are the amount an entity expends to maintain and operate the general business. Operating expenses include research and development, marketing, general and administrative, amortization of intangible assets (i.e. patents, good will, etc.), etc.
In addition, when an entity purchases a capital asset, such as a building or equipment, they expense a portion of the asset over a number of years; this is called depreciation. Depreciation expense is an accounting expense that is deducted from net income.
Operating income is equal to revenues minus cost of goods sold and operating expenses. In other words, it measures the profits or losses of the day to day operations of the business. Another name for Operating Income is Earnings Before Interest and Taxes (EBIT).
Related Reading: What is Operating Cash Flow?
To obtain net income, further adjustments must be made to account for interest income and expense, income tax expenses, and other extraordinary and miscellaneous items.
Revenues minus all expenses equals net income (profits or losses). Profits are also referred to as net income or the “bottom line” because profits are reported at the bottom of the income statement. Some analysts call these “accounting profits” because they include non-cash accounting entries such as depreciation and amortization.
Income Statement Format
- Cost of Goods Sold Expense
= Gross Profit (or Loss)
- Operating Expenses (R&D, selling & adm., depreciation, etc)
= Operating Income
+ investment income
- Interest Expense
+/- Non Recurring Events (Extraordinary items)
= Profit or Net Income
Purpose of the Income Statement
The purpose of the income statement is to provide the financial earnings performance of the entity over a specific period of time. It is also referred to as a profit and loss statement or earnings statement.
The format of the income statement components allows for dissecting the revenues, expenses, operating income, and profits of an entity. The income statement is one of three critical company financial statements for investor analysis.
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