Income statement

Income statements for companies indicate how Net Revenue (money received from the sale of products and services before expenses are taken out, also known as the "top line") is transformed into Net Income (the result after all revenues and expenses have been accounted for, also known as the "bottom line"). The purpose of the income statement is to show managers and investors whether or not the company made or lost money during the period being reported.

Also called Profit and Loss Statement (P&L), outside the USA or in reference to charitable organizations Statement of Activities and Changes in Net Assets.

Usefulness and limitations of income statement

Income statement should help investors and creditors:

evaluate the past performance of the enterprise
predict future performance
assess the risk of achieving future cash flows.

However, information in an income statement has several limitations:

items that might be relevant but cannot be reliably measured are not reported (e.g. brand recognition and loyalty)
some numbers depend on accounting methods used (e.g. using FIFO or LIFO accounting to measure inventory level)
some numbers depend on judgments and estimates (e.g. depreciation expense depends on estimated useful life and salvage value).

Single-step income statement

In the single-step statement, just two groups exist: revenues and expenses. Expenses are deducted from revenues to get net income (single step). Its main advantage is simplicity, but more and more companies choose multiple-step statements. The basic format is shown below.

Revenues Net sales ____________________$3,400,000 Rent revenue _________________ 40,000 Interest revenue _____________ 12,000 Total revenue _____________ 3,452,000 Expenses (usually sorted by amount) Cost of goods sold ___________ 2,000,000 Selling expenses _____________ 450,000 Administrative expenses ______ 350,000 Interest expense _____________ 45,000 Total expense _____________ 2,845,000 Income before taxes ____________ 607,000 Income taxes ___________________ 182,100 Net income _____________________ 424,900 Earnings per share _____________ $4.25

Multiple-step income statement

It is argued that multiple-step income statement provides more useful information because it separates operating and non-operating activities and classifies expenses by function. It allows instant comparisons and ratio computations which evaluate performance of the company. The basic sections are shown below. __ Net Revenue | - Cost of Sales (or Cost of Goods Sold) | = Gross Margin or Profit | - Selling Expenses |> Operating Section - General and Administrative Expenses | = Operating Profit __| - Interest Expense | + Other Revenues or Gains |> Non-operating Section - Other Expenses or Losses __| = Earnings Before Taxes - Taxes = Earnings Before Irregular Items __ -/+ Discontinued Operations | -/+ Extraordinary Items |> Irregular Items -/+ Changes in Accounting Principle __| = Net Income Earnings Per Share

Items on income statement

Operating section

Net Revenue - Inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations. Usually presented as sales minus sales discounts, returns, and allowances.
Expenses - Outflows or other using-up of assets or incurrence of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations.
- Cost of goods sold - represents the amount a product cost you to produce
- General and administrative expenses (G & A) - represent expenses to manage the business (officer salaries, legal and professional fees, utilities, insurance, depreciation of office building and equipment, stationery supplies)
- Selling expenses - represent expenses needed to sell products (e.g., sales salaries and commissions, advertising, freight, shipping, depreciation of sales equipment)
- R & D expenses - represent expenses included in research and development
- Depreciation - represents costs associated with depreciated assets

Non-operating section

Other revenues or gains - revenues and gains from other than primary business activities (e.g. rent, patents). It also includes unusual gains and losses that are either unusual or infrequent, but not both (e.g. sale of securities or fixed assets).
Other expenses or losses - expenses or losses not related to primary business operations.

Irregular items

They are reported separately because this way users can better predict future cash flows - irregular items most likely won't happen next year. These are reported net of taxes.

Discontinued operations is the most common type of irregular items. Shifting business location, stopping production temporarily, or changes due to technological improvement do not qualify as discontinued operations.
Extraordinary items are both unusual (abnormal) and infrequent, for example, unexpected nature disaster, expropriation, prohibitions under new regulations. Note: nature disaster might not qualify depending on location (e.g. frost damage in Canada would not qualify whereas in tropics would).
Changes in accounting principle is, for example, changing method of computing depreciation from straight-line to sum-of-the-years'-digits. However, changes in estimates (e.g. estimated useful life of a fixed asset) do not qualify.

Earnings per share

Because of its importance, earnings per share (EPS) are required to be disclosed on the face of the income statement. A company which reports any of the irregular items must also report EPS for these items either in the statement or in the notes.

$Earnings\ per\ share = \frac{net\ income - preferred\ stock\ dividends}{weighted\ average\ of\ common\ stock\ shares\ outstanding}$

There are two forms of EPS reported:

Basic: in this case "weighted average of shares outstanding" includes only actual stocks outstanding.
Diluted: in this case "weighted average of shares outstanding" is calculated as if all stock options, convertible bonds, and other securities that could be transformed into shares are transformed. This way number of shares increases and EPS decreases. Diluted EPS is considered to be a more accurate way to measure EPS.

Alternative setup of multiple-step income statement

Setups of income statements come in many shapes and forms. Below is an alternative definition which carries a direct relationship to terminology commonly used in financial analysis. On the right hand side of the table several alternative suggestions for terminology are listed - economics and accounting is by no means a discipline with a single standard definition of terms used. Hence, part of the skill in understanding income statements and balance sheets is to see through the words.

Income statement item Acronym spelled out Alternative terminology Revenues Sales, Income, Turnover -CoGS Cost of Goods Sold Cost of sales

- EBITDA Earnings before I+T+D+A Gross margin, Gross profit, Operating margin - Depreciation - Amortization

- EBIT Earnings before I+T - Interest Financial items, Financial income, Financial expense

- EBT Earnings before Taxes Pretax net income - Taxes

- E Earnings Net income

Simple example: Colgate-Palmolive income statement

COLGATE-PALMOLIVE COMPANY CONSOLIDATED STATEMENTS OF INCOME (Dollars in Millions Except Per Share Amounts) For the years ended December 31, 2004 2003 2002

-- Net sales $ 10,584.2 $ 9,903.4 $ 9,294.3 Cost of sales 4,747.2 4,456.1 4,224.2

-- Gross profit 5,837.0 5,447.3 5,070.1 Selling, general and administrative expenses 3,624.6 3,296.3 3,034.0 Other (income) expense, net 90.3 (15.0) 23.0

-- Operating profit 2,122.1 2,166.0 2,013.1 Interest expense, net 119.7 124.1 142.8

-- Income before income taxes 2,002.4 2,041.9 1,870.3 Provision for income taxes 675.3 620.6 582.0

-- Net income $ 1,327.1 $ 1,421.3 $ 1,288.3

-- Earnings per common share, basic $ 2.45 $ 2.60 $ 2.33 Earnings per common share, diluted $ 2.33 $ 2.46 $ 2.19

Complex example: Viacom, Inc. income statement

VIACOM INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In millions, except per share amounts)

-- Year Ended December 31, 2004 2003 2002

-- Revenues $ 22,525.9 $ 20,827.6 $19,186.8 Expenses: Operating 12,545.8 11,879.8 10,735.5 Selling, general and administrative 4,142.1 3,732.3 3,498.6 Depreciation and amortization 809.9 741.9 711.8 Impairment charge (Note 3) 17,997.1 — —

-- Total expenses 35,494.9 16,354.0 14,945.9

-- Operating income (loss) (12,969.0) 4,473.6 4,240.9 Interest expense (718.9) (742.9) (799.1) Interest income 25.3 11.7 12.0 Other items, net 7.6 (3.0) (32.9)

-- Earnings (loss) from continuing operations before income taxes, equity in earnings (loss) of affiliated companies and minority interest (13,655.0) 3,739.4 3,420.9 Provision for income taxes (1,378.6) (1,497.0) (1,338.3) Equity in earnings (loss) of affiliated companies, net of tax (20.8) .1 (37.3) Minority interest, net of tax (5.1) (4.7) (3.3)

-- Net earnings (loss) from continuing operations (15,059.5) 2,237.8 2,042.0

-- Discontinued operations (Note 2): Earnings (loss) from discontinued operations (1,182.7) (718.8) 255.3 Income taxes, net of minority interest 92.4 (83.6) (90.7)

-- Net earnings (loss) from discontinued operations (1,090.3) (802.4) 164.6

-- Net earnings (loss) before cumulative effect of accounting change (16,149.8) 1,435.4 2,206.6 Cumulative effect of accounting change, net of minority interest and tax (Note 1) (1,312.4) (18.5) (1,480.9)

-- Net earnings (loss) $ (17,462.2) $ 1,416.9 $ 725.7

-- Basic earnings (loss) per common share: Net earnings (loss) from continuing operations $ (8.78) $ 1.28 $1.16 Net earnings (loss) from discontinued operations $ (.64) $ (.46) $ .09 Net earnings (loss) before cumulative effect of accounting change $ (9.42) $ .82 $ 1.26 Cumulative effect of accounting change $ (.77) $ (.01) $ (.84) Net earnings (loss) $(10.19) $ .81 $ .41 Diluted earnings (loss) per common share: Net earnings (loss) from continuing operations $ (8.78) $ 1.27 $ 1.15 Net earnings (loss) from discontinued operations $ (.64) $ (.46) $ .09 Net earnings (loss) before cumulative effect of accounting change $ (9.42) $ .82 $ 1.24 Cumulative effect of accounting change $ (.77) $ (.01) $ (.83) Net earnings (loss) $(10.19) $ .80 $ .41 Weighted average number of common shares outstanding: Basic 1,714.4 1,744.0 1,752.8 Diluted 1,714.4 1,760.7 1,774.8 Dividends per common share $ .25 $ .12 $ —

External links

Income Statement Explanation with examples.

Understanding Income Statements

Generally Accepted Accounting Principles

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