Income Statement – Definition, Format and Example

• What is Income Statement
• Components of Income Statement
• Income statement format
• Income statement example
• Why do businesses prepare income statement?
• How do businesses prepare income statement?

What is Income Statement

The income statement presents information on the financial results of a company’s business activities over a period of time.

It communicates to users how much revenue the company has generated during the period and the cost incurred by it in connection to generating such revenues. Income Statement is also called by different names as “statement of operations” or “statement of earnings” or “profit and loss statement”.

A business engaged in services usually prepares an income statement instead of profit & loss a/c. While the objective remains the same, owing to the difference in the nature of the business, few components are different in the income statement.

Components of income statement

Revenue

Revenues are the amounts from the sale of goods and services in the normal course of business. And net Revenue means all proceeds from the sale of goods and services excluding the returns.

 For example, Zen Phones, an electronic store selling phones and computers. This implies that Company A is in the sales business and its revenue is from the sale of computers and mobile phones.

Let’ take another example.

Max associates is a law firm rendering consultancy services to its clients. Here, they are engaged in the business of rendering services for which it charges a fee. So here fee is the revenue forming part of Income Statement.

However, there are also other forms of revenue such as interest income, royalty income, rental income etc. that will be part of the statement.

Expenses

Expenses are the amounts incurred to generate revenue and includes the cost of rendering services such as operating expenses, interest payments, rent, salaries and wages, taxes etc.

For example, Max associates is a law firm providing legal consultancy services to its clients.

In the process of rendering services, the company will incur various expenses such as promotional expense (advertisement expenses), sales managers’ salaries, depreciation on the usage of fixed assets and other administrative expenses to earn revenue by rendering services. All these expenses form part of the income statement as they are incurred in relation to such revenues.

Net income

Here, the net income is nothing but an excess of revenue over the expenses. In other words, after deducting all the expenses and taxes from the revenue earned during the period, remaining is the net income from the business operation.

Cost of goods sold (COGS)

The cost of goods sold (COGS) is any direct cost related to the production of goods that are sold or the cost of inventory you acquire to sell to consumers. It does not include overhead expenses related to the general operation of the business, such as rent. Cost of goods sold is reported on a company's income statement.

Read more: Cost of Goods Sold (COGS): Definition, Formula, Calculation and Example

Gross profit

Gross Profit is defined as net sales minus the cost of goods sold. Gross profit is sometimes referred to as gross margin.

Marketing, advertising, and promotion expenses

These are the expenses related to selling goods and/or services. Marketing, advertising, and promotion expenses are often grouped together as they are similar in nature and relate to selling.

EBITDA

EBITDA aka Earnings before Interest, Tax, Depreciation, and Amortization is calculated by subtracting SG&A expenses (excluding amortization and depreciation) from gross profit.

Depreciation expense

Depreciation, also known as amortization are non-cash expenses that are created by accountants to spread out the cost of capital assets such as property, plant, and equipment (PP&E).

Operating income (or EBIT)

Operating income is nothing but whatever your business has earned through its regular operations. In other words, it’s the profit before any non-operating income, non-operating expenses, interest, or taxes are subtracted from revenues. EBIT is a term commonly used in finance and stands for Earnings Before Interest and Taxes.

Interest

It is not uncommon for companies to call interest expense and interest income separately in the income statement so that reconciliation of the difference between EBIT and EBT is more accuarate.

Other expenses

These expenses are specific to the industry your company comes under. Since each industry expenses are unique in nature, whatever transactions do not cater to other categories, fall under "other expenses".

EBT (Pre-Tax Income)

EBT stands for Earnings Before Tax, also known as pre-tax income, and is found by subtracting interest expense from Operating Income. This is the final subtotal before arriving at net income.

Income taxes

Income taxes are the relevant taxes charged on pre-tax income. The total tax expense can consist of both current taxes and future taxes.

Net income

This is calculated by deducting income taxes from pre-tax income. This is the amount that flows into retained earnings on the balance sheet, after deductions for any dividends.

Format of income statement

A format of an income statement is very important as it is the means of communication of operating results to outsiders. The income statement format includes details such as the company’s name, the title stating, “Income Statement”, the period covered, and other key components as discussed above.

Single-step income statement format

Income statement example

Below is the income statement example of Max Associates, who are into legal consultancy service.

Why do businesses prepare income statements?

We must mainly remember one thing that a company does not operate wholly on owned funds, it borrows money from outsiders to run its operational activities.

So, the external users of income statement i.e. investors, creditors and other lenders must make decisions about resource allocation as to where to put their money. They use the income statement to find out answers to the questions they may have about the future profitability of the business.

• For investors – This statement will help them to decide whether to keep or sell the shares they own in the company. The investors also use the income statement to determine the ability of a company to pay dividends.
  
  
• For lenders - Lenders use the income statement to find out whether the company will be able to repay the loan with interest in the future.
  
  
• Creditors – They use the income statement to determine whether the company will be profitable enough to repay their debts as they come due.

How do businesses prepare income statement?

With the help of ERP software, preparing an income statement is made a lot easier. Gone are those days where you need to wait for the closure of books to determine the net income. Today, most businesses have automated the preparation of various financial statement including income statement using ERP software or accounting software.

Usage accounting software has helped the business owners to frequently check the income statement and accordingly take corrective actions when required.