What’s an Income Statement?

Perhaps one the most important financial statements acceptable around the world is the income statement which shows us the financial capabilities of an organization. While a company may boast about their revenues or profits, the income statement allows for every detail to be mentioned properly and transparently and therefore if the company has huge operating costs which are increasing Year-on-year, the high revenues and profits might not be as positive as it first looks to be. The income statement is therefore a statement which accounts for a true financial strength of the organization over a fixed period.

When we talk about the income statement being communicated over a fixed period, we are generally saying that it can be prepared monthly, quarterly, semi-annually and annually. Income statements for strategic decisions are generally prepared for a shorter period shedding light on which months or quarters under or over performed. On the contrary, longer time frame income statements, are studied by creditors and investors who analyse how the company performed for a longer period.

The statement takes us through a plethora of relevant information starting from revenues to arriving at gross profit. Then we proceed onto deducting operating expenses and depreciation to arrive at operating profit or EBIT. We further deduct interest and tax to ascertain Net profit or Earning per share which is primarily concerned with the perceived returns a shareholder is getting for their investment.

Some important concepts which are required to be covered in order to understand what constitutes the income statement are as follows –

   1)  Operating Revenue – revenue emerging from core business activities is termed as operating revenue. For example, a baker’s core business activity is making bread. Revenues made and accrued on the sale of bread is to be termed as operating revenue.

   2)  Non-Operating Revenue – revenue emerging from secondary sources oblivious of the revenue from core business activities are called non-operating revenues. For example, when the baker earns money by renting the porch outside his shop to a lemonade stall, it can be termed as a non-operating revenue.

   3)  Gains – gains from sale of fixed assets are also to be considered in the income statement. Translational gains of foreign currency are also to be accommodated.

   4)  Primary activity-based expenses – expenses borne out of core business activities are included in the income statement. For example, the cost associated with transporting wheat and baking soda from the farmer/shop to his shop is a direct cost involved.

   5)  Expenses based on non-core activities – Interest on a loan to be repaid are included as expenses which must be meted out and therefore are considered in the income statement.

   6)  Losses – losses on sale of fixed assets and translational losses of foreign currency are also accommodated.

While the primary aim of the income statement is to provide transparent profitability reports on the business activities to its stakeholders, it does much more than that. An income statement provides enough information for a company to be compared to that of others within the same sector and business group. Based on all these metrics, management takes decisions pertaining to expansion, mergers & acquisitions, diversifications and so on. Truly, without an income statement the financial and operating ability as well as decisions taken would not be as well-thought out and informed.