Income Statement: How to Read and Use It (2024)

What Is an Income Statement?

An income statement is one of the three important financial statements used for reporting a company’sfinancial performanceover a specific accounting period. The other two key statements are the balance sheetand the cash flow statement.

The income statement focuses on the revenue,expenses, gains, and losses reported by a company during a particular period. Also known as the or the statement of revenue and expense, an income statement provides valuable insights into a company’s operations, the efficiency of its management, underperforming sectors, and its performance relative to industry peers.

Key Takeaways

  • An income statement is one of the three major financial statements, along with the balance sheet and the cash flow statement, that report a company’s financial performance over a specific accounting period.
  • The income statement focuses on the revenue,expenses, gains, and losses of a company during a particular period.
  • An income statement provides valuable insights into a company’s operations, the efficiency of its management, underperforming sectors, and its performance relative to industry peers.

Income Statement: How to Read and Use It (1)

Understanding the Income Statement

The income statement is an integral part of the company performance reports that must be submitted to the U.S. Securities and Exchange Commission (SEC). While a balance sheet provides the snapshot of a company’s financials as of a particular date, the income statement reports income through a specific period, usually a quarter or a year, and its headingindicates the duration, which may read as “For the (fiscal) year/quarter ended June 30, 2021.”

Income Statement: How to Read and Use It (2)

The income statement focuses on four key items: revenue,expenses, gains, and losses. It does not differentiate between cash and non-cashreceipts(sales in cash vs. sales on credit) or cash vs. non-cash payments/disbursem*nts (purchases in cash vs. purchases on credit). It starts with the details of sales and then works down to computenet incomeand eventually earnings per share (EPS). Essentially, it gives an account of how the net revenuerealized by the company gets transformed into net earnings (profit or loss).

Revenue and Gains

The following are covered in the income statement, though its format may vary, depending upon the local regulatory requirements, the diversified scope of the business, and the associated operating activities:

Operating Revenue

Revenue realized through primary activities is often referred to as operating revenue. For a company manufacturing a product, or for a wholesaler, distributor, or retailer involved in the business of selling that product, the revenue from primary activities refers to revenue achieved from the sale of the product. Similarly, for a company (or its franchisees) in the business of offering services, revenue from primary activities refers to the revenue or fees earned in exchange for offering those services.

Non-Operating Revenue

Revenue realized through secondary, noncore businessactivities is often referred to as nonoperating, recurring revenue. This revenue is sourced from the earnings that are outside the purchase and sale of goods and services and may include income from interest earned on business capital parked in the bank, rental income from business property, income from strategic partnerships like royalty payment receipts, or income from an advertisem*nt display placed on business property.

Gains

Also called other sundry income, gains indicate the net money made from other activities, like the sale of long-term assets. These include the net income realized from one-time nonbusiness activities, such as a company selling its old transportation van, unused land,or a subsidiary company.

Revenue should not be confused with receipts. Payment is usually accounted for in the period when sales are made, or services are delivered. Receipts are the cash received and are accounted for when the money is received.

A customer may take goods/services from a company on Sept. 28, which will lead to the revenue accounted for in September. The customer may be given a 30-day payment window due to his excellent credit and reputation, allowing until Oct. 28 to make the payment, which is when the receipts are accounted for.

Expenses and Losses

A business's cost to continue operating and turning a profit is known as an expense. Some of these expenses may be written off on a tax return if they meet Internal Revenue Service (IRS) guidelines.

Primary-Activity Expenses

These are all expenses incurred for earning the average operating revenue linked to the primary activity of the business. They include the cost of goods sold (COGS); selling, general, and administrative (SG&A) expenses; depreciation or amortization; and research and development (R&D) expenses. Typical items that make up the list are employee wages, sales commissions, and expenses for utilities such as electricity and transportation.

Secondary-Activity Expenses

These are all expenses linked to noncore business activities, like interest paid on loan money.

Losses as Expenses

These are all expenses that go toward a loss-making sale of long-term assets, one-time or any other unusual costs, or expenses toward lawsuits.

While primary revenue and expenses offer insights into how well the company’s core business is performing, the secondary revenue and fees account for the company’s involvement and expertise in managing ad hoc, non-core activities. Compared with the income from the sale of manufactured goods, asubstantially high-interest income from money lying in the bank indicates that the business may not be using the available cash to its full potential by expanding the production capacity, or that it is facing challenges in increasing its market share amid competition.

Recurring rental income gained by hosting billboards at the company factory along a highway indicates that management is capitalizing upon the available resources and assets for additional profitability.

Income Statement Structure

Mathematically, net income is calculated based on the following:

Net Income = (Revenue + Gains) - (Expenses + Losses)

To understand the above formula with some real numbers, let’s assume that a fictitious sports merchandise business, which additionally provides training, is reporting its income statement for a recent hypothetical quarter.

Income Statement: How to Read and Use It (3)

It received $25,800 from the sale of sports goods and $5,000 from training services. It spent various amounts listed for the given activities that total of $10,650. It realized net gains of $2,000 from the sale of an old van, and it incurred losses worth $800 for settling a dispute raised by a consumer. The net income comes to $21,350 for the given quarter. The above example is the simplest form of income statement that any standard business can generate. It is called the single-step income statement as it is based on a simple calculation that sums up revenue and gains and subtracts expenses and losses.

However, real-world companies often operate on a global scale, have diversified business segments offering a mix of products and services, and frequently get involved in mergers, acquisitions, and strategic partnerships. Such a wide array of operations, diversified set of expenses, various business activities, and the need for reporting in a standard format per regulatory compliance leads to multiple and complex accounting entries in the income statement.

Listed companies follow the multiple-step income statement, which segregates the operating revenue,operating expenses, and gains from the nonoperating revenue, nonoperating expenses, and losses, and offers many more details through the income statement produced this way.

Essentially, the differentmeasures of profitability in a multiple-step income statement are reported at four different levels in a business's operations: gross, operating, pretax, and after-tax. As we’ll see shortly in the following example, this segregation helps in identifying how the income and profitability are moving/changing from one level to the other. For instance, high gross profit but lower operating income indicates higher expenses, while higher pretax profit and lower post-tax profit indicate loss of earnings to taxes and other one-time, unusual expenses.

Let’s look at an example based on the 2021 annual income statements of two large, publicly listed, multinational companies from different sectors: technology (Microsoft) and retail (Walmart).

Reading Income Statements

The focus in this standard format is to calculate the profit/income at each subhead of revenue and operating expenses and then account for mandatory taxes, interest, and other nonrecurring, one-time events to arrive at the net income that applies to common stock. Though calculations involve simple additions and subtractions, the order in which the various entries appear in the statement and their relationships often get repetitive and complicated. Let’s take a deep dive into these numbers for a better understanding.

Revenue Section

The first section, titled Revenue, indicates that Microsoft’s gross (annual) profit, or gross margin, for the fiscal year ending June 30, 2021, was $115.86 billion. It was arrived at by deducting the cost of revenue ($52.23 billion) from the total revenue ($168.09 billion) realized by the technology giant during this fiscal year. Just over 30% of Microsoft’s total sales went toward costs for revenue generation, while a similar figure for Walmart in its fiscal year 2021 was about 75% ($429 billion/$572.75 billion). It indicates that Walmart incurred much higher cost than Microsoft to generate equivalent sales.

Operating Expenses

The next section, called Operating Expenses, again takes into account Microsoft’s cost of revenue ($52.23 billion) and total revenue ($168.09 billion) for the fiscal year to arrive at the reported figures. As Microsoft spent $20.72 billion on R&D and $25.23 billion on SG&A expenses, total operating expensesare computed by summing all these figures ($52.23 billion + $20.72 billion + $25.23 billion = $98.18 billion).

Reducing total operating expenses from total revenue leads to operating income (or loss)of $69.92 billion ($168.09 billion - $98.18 billion). This figure represents the earnings before interest and taxes (EBIT) for its core business activities and is again used later to derive the net income.

A comparison of the line items indicates that Walmart did not spend anything on R&D and had higher SG&A and total operating expenses than Microsoft.

Income From Continuing Operations

The next section, titled Income from Continuing Operations, adds net other income or expenses (like one-time earnings), interest-linked expenses, and applicable taxes to arrive at the net income from continuing operations($61.27 billion) for Microsoft, which is nearly 60% higher than that of Walmart ($13.67 billion).

After discounting for any nonrecurring events, it’s possible to arrive at the value of net income applicable to common shares. Microsoft had a much higher net income of $61.27 billion compared with Walmart’s $13.67 billion.

Earnings per share are computed by dividingthe net income figure by the number of weighted average shares outstanding. With 7.55 billion outstanding shares for Microsoft, its 2021 EPS came to $8.12 per share ($61.27 billion ÷ 7.55 billion). With Walmart having 2.79 billion outstanding shares that fiscal year, its EPS came to $4.90 per share ($13.67 billion ÷ 2.79 billion).

Microsoft had a lower cost for generating equivalent revenue, higher net income from continuing operations, and higher net income applicable to common shares compared with Walmart.

Uses of Income Statements

Though the primary purpose of an income statement is to convey details of profitability and business activities of the company to the stakeholders, it also provides detailed insights into the company’s internal activities for comparison across different businesses and sectors. By understanding the income and expense components of the statement, an investor can appreciate what makes a company profitable.

Based on income statements, management can make decisions like expanding to new geographies, pushing sales, expanding production capacity, increasing the use of or the outright sale of assets, or shutting down a department or product line. Competitors also may use them to gain insights about thesuccess parameters of a company and focus areas such as lifting R&D spending.

Creditors may find income statementsof limited use, as they are more concerned about a company’s future cash flows than its past profitability.Research analysts use the income statement to compare year-on-yearand quarter-on-quarterperformance. One can infer, for example, whether a company’s efforts at reducing the cost of sales helped it improve profits over time, or whether management kept tabs on operating expenses without compromising on profitability.

What Are the Four Key Elements of an Income Statement?

(1) Revenue,(2) expenses, (3) gains, and (4) losses. An income statement is not a balance sheet or a cash flow statement.

What Is the Difference Between Operating Revenue and Non-Operating Revenue?

Operating revenue is realized through a business' primary activity, such as selling its products. Non-operating revenue comes from ancillary sources such as interest income from capital held in a bank or income from rental of business property.

What Insights Should You Look for in an Income Statement?

The income and expense components can help an investor learn what makes a company profitable (or not). Competitors can use them to measure how their company compares on various measures. Research analysts use them to compare performance year-on-year and quarter-on-quarter.

The Bottom Line

An income statement provides valuable insights into various aspects of a business. It includes readings on a company’s operations, the efficiency of its management, the possible leaky areas that may be erodingprofits, and whether the company is performing in line with industry peers.

Income Statement: How to Read and Use It (2024)

FAQs

How to properly read an income statement? ›

Your income statement follows a linear path, from top line to bottom line. Think of the top line as a “rough draft” of the money you've made—your total revenue, before taking into account any expenses—and your bottom line as a “final draft”—the profit you earned after taking account of all expenses.

What is an income statement and how is it used? ›

An income statement is a financial statement that shows you the company's income and expenditures. It also shows whether a company is making profit or loss for a given period. The income statement, along with balance sheet and cash flow statement, helps you understand the financial health of your business.

How do you work out an income statement? ›

The basic formula for an income statement is Revenues – Expenses = Net Income. This simple equation shows whether the company is profitable. If revenues are greater than expenses, the business is profitable.

What is the main thing you can learn from an income statement? ›

The income statement presents information on the financial results of a company's business activities over a period of time. The income statement communicates how much revenue the company generated during a period and what costs it incurred in connection with generating that revenue.

How to see an income statement? ›

via your agent ■ via myGov – income statement ■ your employer – payment summary.
  1. Through myGov.
  2. Through your employer.
  3. Using a registered tax agent.
  4. For more information.
  5. Income. Statement.

What is the basic income statement? ›

The basic income statement shows how much revenue a company earned (or lost) over a specific period (usually for a year or some portion of a year). An income statement also shows the costs and expenses associated with earning that revenue. Another term for an income statement is a profit and loss statement.

What is the income statement used to record? ›

An income statement is a financial report detailing a company's income and expenses over a reporting period. It can also be referred to as a profit and loss (P&L) statement and is typically prepared quarterly or annually. Income statements depict a company's financial performance over a reporting period.

What number on an income statement is most important? ›

Net income

Net income is sometimes referred to as a company's bottom line because it's found at the bottom of its income statement. It's important to know a company's net income because it shows profitability, but it's also important to calculate other figures, such as earnings per share (EPS).

What do income statements show the summary of? ›

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.

How do you explain an income statement? ›

An income statement is one of the three major financial statements, along with the balance sheet and the cash flow statement, that report a company's financial performance over a specific accounting period. The income statement focuses on the revenue, expenses, gains, and losses of a company during a particular period.

How to analyse an income statement? ›

Basic analysis of the income statement usually involves the calculation of gross profit margin, operating profit margin, and net profit margin, which each divide profit by revenue. Profit margin helps to show where company costs are low or high at different points of the operations.

What is income statement format? ›

The income statement can be presented in a “one-step” or “two-step” format. In a “one-step” format, revenues and gains are grouped together, and expenses and losses are grouped together. These amounts are then totaled to show net income or loss.

How to read and understand a financial statement? ›

On the top half you have the company's assets and on the bottom half its liabilities and Shareholders' Equity (or Net Worth). The assets and liabilities are typically listed in order of liquidity and separated between current and non-current. The income statement covers a period of time, such as a quarter or year.

How should an income statement be formatted? ›

The income statement can be presented in a “one-step” or “two-step” format. In a “one-step” format, revenues and gains are grouped together, and expenses and losses are grouped together. These amounts are then totaled to show net income or loss.

How to analyze a P&L statement? ›

Use these seven steps to help you read and analyze a P&L report:
  1. Define the revenue. ...
  2. Understand the expenses. ...
  3. Calculate the gross margin. ...
  4. Calculate the operating income. ...
  5. Use budget vs. ...
  6. Check the year-over-year (YoY) ...
  7. Determine net profit.
Mar 10, 2023

How does Warren Buffett interpret financial statements? ›

Warren looks for consistency in a company's financial statements. Consistency in high gross profit margins, little debt, massive earnings is all telltale signs that this is a super-company worth investing. The financial statement informs you all of these lesser-known facts for free.

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