The Income Statement
The Income Statement is the most basic way a company keeps score. The Income Statement, sometimes called a Profit & Loss statement, or P & L, lists business revenues/sales, subtracts expenses, and shows whether the company made a profit or suffered a loss. The main value of an Income Statement, aside from its obvious value of serving as a financial scorecard, is its ability to show a detailed flow of revenues, costs, and expenses over a short- or long-term period.
Think of it this way: The Balance Sheet, which shows assets and liabilities, states the financial position of a company; the Income Statement, which shows revenues and expenses, indicates operational results. The Balance Sheet, in short, shows where you are − the Income Statement can not only show where you are but also how you got there.
The typical Income Statement is broken down into two parts: Sales and Expenses. Here's an example of a very simple Income Statement:
Year Ending December 31, 2008
|Cost of goods sold||$4,000.00|
|Total Operating Expenses||$7,500.00|
|Net Profit After Taxes (NPAT)||$5,000.00|
Keep in mind the above is a very simple example. Income Statements can include a significant amount of detail; instead of listing all utility expenses under the Utilities category, you could choose to break out electrical, water, phone, and natural gas separately. While all your expenses will be added together under the Utilities category, if you want to show a high level of detail on your Income Statement you certainly can. Most companies use the Income Statement as a high-level overview of company results, and use other reports to analyze expense category details.
Here's a quick breakdown of the major categories:
- Net Sales: The proceeds of all sales of goods and services. Amounts for discounts, price breaks, or returns are subtracted from total sales to determine Net Sales. Net sales are considered the "top line" of an Income Statement; when a businessperson says, "We need to focus on improving top line results," in plain terms he or she wants to increase sales.
- Consulting Income: In our example we showed consulting income separately from Net Sales; if some of your revenue comes from product sales and some comes from installing those products, for instance, you may choose to break the revenue from those two functions out. You could, if you wish, show all revenues as Net Sales − in that case your Net Sales will be equal to your Total Revenue.
- Salaries: Wages paid to employees.
- Cost of Goods Sold: The cost of obtaining raw materials, producing finished goods, or purchasing finished goods for resale.
- Utilities: All utility costs.
- Supplies: Items that do not go into finished goods but are necessary for production or operations. For example, oil to lubricate equipment is a supply, not a direct productive material.
- Total Operating Expenses: The sum of all expense categories.
- Net Income/Loss: Total Revenue minus Total Operating Expenses.
- Taxes: Estimated taxes due on any profits
- Net Profit after Taxes (NPAT): Net profits after all expenses and taxes are paid. Many people refer to this line item as the "bottom line," since it appears at the end of the Income Statement.
Keep in mind while some people refer to Net Income/Loss before taxes as the bottom line, most deduct the estimated tax liability to yield a more accurate bottom line result.
Income Statements for publicly-traded companies or for companies with more than one stockholder often include a line for Earnings per Share (EPS). Earnings per share are determined by dividing Net Income after Taxes by the total shares outstanding.
Here's an example:
Net Profit After Taxes:
|Total Shares Outstanding||100|
|Earnings per Share||$50|
While the Income Statement provides an objective snapshot of company operating results for a specific time period, it is also incredibly useful for determining changes in operating results. For example, here is the same Income Statement, but we have included results from the previous year as well:
|Cost of goods sold||$4,000.00||$3,000.00|
|Total Operating Expenses||$7,500.00||$6,400.00|
|Net Profit After Taxes (NPAT)||$5,000.00||$1,200.00|
From 2007 to 2008, sales and consulting income increased by $7,000 while Operating Expenses only increased by $1,100. The top line nearly doubled and since expenses only rose by 15%, profits quadrupled from $1,200 to $5,000. Comparing Income Statements for different time periods is an objective way to evaluate the success of marketing and sales initiatives as well as cost-cutting and productivity improvement efforts.