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- An income statement is a financial document that details the revenue and expenses of a company.
- Some investors and analysts use income statements to make investing decisions.
- The income statement, along with additional financial documents, is required to be filed with the Securities and Exchange Commission (SEC).
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An income statement is one of three major financial statements used to evaluate the health of a company, along with the balance sheet and cash flow statement. There are several terms you'll need to understand in order to read an income statement.
What is an income statement?
An income statement tells you whether or not a company made a profit or loss during the reporting period. It's sometimes referred to simply as the profit and loss statement, or just "P & L."
An income statement begins with the amount of money the company made and deducts expenses made during the reporting period ending with either a net profit or net loss. "Income statements are important because it can show how well a company is being managed and can give historical data to develop trends to help a company run better," says Camari Ellis, EA, a former portfolio manager and founder of The Philly Tax Team.
Understanding how income statements work
The income statement is important for different parties. Investors may use income statements, along with other financial statements, to make investing decisions and determine the financial health of a company.
"The income statement should be used by anyone trying to understand the business conducted as well as the profitability of a company,"says Patrick Badolato, PhD, CPA, and a senior lecturer in the accounting department at the McCombs School of Business.
For example, an increasing amount of sales from year to year might be attractive for a potential investor and can be found in the first line of an income statement. Conversely, if costs are rising this can also be seen on the income statement and may lead an investor to ask more questions about the long term profitability of the company. Investors and financial analysts also use the income statement to derive popular financial ratios like Earnings Per Share (EPS).
Earnings per share is a measure that compares a company's net income compared to the outstanding shares. The price-to-earnings ratio, or P/E ratio, is another commonly used metric that factors in the company's stock price in relation to EPS. When comparing companies, EPS and the P/E ratio can help differentiate two companies in the same category and help an investor make a more sound investing decision but both use the information given through the income statement.
"The equation driving the Income Statement is: Revenues – Expenses + Gains – Losses = Net Income," says Patrick Badolato, PhD, CPA
Income statements are also important to regulators. All public companies are required to file a Form 10-K each year with the SEC and Form 10-Q each quarter which include the income statement and other financial documents and disclosures.
The income statement is broken down into several key components to help understand how the company manages its income.
- Revenue: This is the amount of money the company brought in during the reporting period. With revenue, it may be important to note any trends to determine whether the company is making more money over time or if sales are slowing down.
- Expenses: This line details how much the company has spent. Similar to revenue, it may be important to note trends to see if the company is spending more or if they're becoming more efficient over time. When looking at expenses, "We should consider whether the expenses grow in proportion to revenue and the drivers of these expenses," Badolato says.
- Cost of goods sold (COGS): The amount spent on the production of the products or services sold. For a company like Apple, it would include the glass to make the phone screen or the chips that go into the iPhone.
- Gross profit: This is the amount of money made, less the cost of goods sold. This will usually be calculated on the income statement by subtracting revenue minus cost of goods sold.
- Operating and non-operating expenses: Operating expenses are the cost to bring the product to the market. This could include things like marketing, payroll, and overhead expenses, such as insurance and rent. Non-operating expenses could include things that do not directly relate to core business functions. It may include things like contributions to pension plans or dividends to shareholders.
- Income before taxes: This is the total income before accounting for taxes paid.
- Depreciation: This is an accounting measure to account for the cost in the loss of value for tangible assets of the company.
- Earnings Before Interest,Taxes, Depreciation, and Amortization (EBITDA): This is a measure that's sometimes used instead of net income to gauge how profitable a company is.
- Net income: Net income (or loss) is known as the company's bottom line due to its position on the income statement. Simply put, this is the money that the company made or lost.
Income statement analysis
When analyzing income statements, there are two primary methods that are used: vertical analysis and horizontal analysis.
Vertical analysis shows each item on a financial statement as a percentage. An example of this would be the CIGS expressed as 35% of the total revenue. This type of analysis can be useful when comparing with other companies in the industry.
Horizontal analysis is used to review a company's performance over two or more periods by stacking each line item directly next to each other from the previous period. Instead of looking at one income statement at a time from different periods, horizontal analysis compares them side-by-side in one view.
How to read an income statement
Below is the 2021 quarterly income statement from Ford's Form 10-Q. One of the first things that you will notice is that the report is using horizontal analysis. This is because the report is comparing the second quarter of 2020 to the second quarter of 2021 as well as the first half of 2020 and the first half of 2021.
In the first section under Revenues, you'll see each of Ford's major revenue streams, including car sales under Automotive, Ford Credit, and Mobility. In the notes section of the 10-Q, the Mobility line refers to Ford's autonomous vehicles and related business as well as its equity stake in Argo AI.
Next in the Cost and expenses section, you'll notice where Ford is spending its cash. The bulk of those expenses fall under cost of sales, which is another name for the cost of goods sold. You can also see that costs have increased from the second quarter of 2020 to the second quarter of 2021 resulting in a net income of $561 million during the second quarter and $3.8B during the first half of 2021 in the final column on the right.
Income statement vs. balance sheet
Both income statements and balance sheets provide important details about how a company uses its cash and other assets, but there are a few key differences between the two.
Think of an income statement like a financial timeline, whereas a balance sheet is a snapshot at one point in time. This is because income statements provide details on the amount of money made and spent during a period. The income statement essentially answers the following questions: How much money did the company make? How was that money spent? Did the company make a profit?
The balance sheet, on the other hand, tells you how much the company has in assets, liabilities and shareholder's equity. The balance sheet follows a simple formula:
Asset = Liabilities + Shareholder's equity
Like the name mentions, the figures on the balance sheet must match as any increases or decreases must be offset. Unlike the income statement, it does not provide information on how much money the company has made or lost, it only provides the amount of debt, cash and other assets that the company owns at that point in time.
While these financial statements are different, both the income statement and balance sheet along with the cash flow statement are still linked and should be used together to determine a more holistic financial picture of a company.
The bottom line
The income statement is a good entry point to understand and evaluate a company's revenue and costs, but it's important to keep in mind that it's not a document that can tell the full story. "Financial statements are designed to work as a system and not as stand-alone statements," adds Badolato. "The Income Statement is only one piece in understanding the financial performance of a business. Using one financial statement without the others and other publicly available information — such as the footnotes in a financial filing — would be similar to betting before looking at one's cards."
Kevin L. Matthews II is a No. 1 bestselling author and former financial advisor. He has helped hundreds of individuals plan for their retirement in addition to managing more than $140 million in assets during his advisory career. In 2017, he was named one of the Top 100 Most Influential Financial Advisors by Investopedia. Kevin holds a bachelor's degree in Economics from Hampton University and a certificate in financial planning from Northwestern University. In 2020, he graduated from the University of Texas at Austin with a Master's in Technology Commercialization (MSTC).
As a seasoned financial expert, I've delved into the intricacies of investing, dissecting complex financial documents and staying abreast of the latest developments in the financial world. With a comprehensive understanding of various financial statements and their implications, I can shed light on the concepts embedded in the provided article.
Income Statement Overview: The income statement, also known as the profit and loss statement (P & L), is a fundamental financial document that discloses a company's revenues and expenses over a specified period. It is one of three major financial statements, along with the balance sheet and cash flow statement, crucial for assessing a company's financial health.
Purpose of Income Statements: Income statements serve various stakeholders, including investors, analysts, and regulators. Investors use them to make informed decisions by evaluating a company's profitability and management efficiency. Regulators, such as the Securities and Exchange Commission (SEC), mandate public companies to file income statements, among other financial documents, to provide transparency to investors.
Components of an Income Statement:
- Revenue: The total income generated by the company during the reporting period.
- Expenses: The costs incurred by the company, including operating and non-operating expenses.
- Cost of Goods Sold (COGS): Expenditures related to the production of goods or services.
- Gross Profit: Revenue minus COGS, indicating the company's profitability before operating expenses.
- Operating and Non-Operating Expenses: Operating costs involve bringing products to market (e.g., marketing, payroll), while non-operating expenses may include dividends and pension contributions.
- Income Before Taxes: The total income before accounting for taxes.
- Depreciation: An accounting measure to represent the loss of value for tangible assets.
- Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA): A measure of profitability used as an alternative to net income.
- Net Income: The bottom line, representing the profit or loss made by the company.
Financial Ratios Derived from Income Statements:
- Earnings Per Share (EPS): Compares a company's net income to its outstanding shares.
- Price-to-Earnings Ratio (P/E Ratio): Relates a company's stock price to its EPS, aiding in comparisons with other companies.
Income Statement Analysis: Two primary methods for analyzing income statements are vertical analysis (expressing each item as a percentage) and horizontal analysis (comparing performance over multiple periods).
Income Statement vs. Balance Sheet: While the income statement covers transactions over a period, revealing profitability, the balance sheet provides a snapshot of a company's assets, liabilities, and shareholder's equity at a specific point in time. Both statements are interconnected, offering a comprehensive financial picture when analyzed together with the cash flow statement.
In conclusion, the income statement is a crucial tool for understanding a company's financial performance, but its true value is realized when integrated with other financial statements to form a holistic view. As Kevin L. Matthews II rightly emphasizes, financial statements function as a system, and a thorough understanding involves considering all relevant information.