In the next few articles we will have a look at the bridge between a company and its stakeholders. A stakeholder can be anyone who has an interest in the company. This can be a person who lives in the same area as the factory, it could be an employee, it could also be investors in the company. Generally anyone who can be affected by decisions the company makes is a stakeholder. In order to let the stakeholders know how the company is doing, the management of the company will produce financial statements. These financial statements are reports that give the public and management a better understanding of how the business is doing.
There are four major financial statements. The Balance Sheet, Income Statement, Statement of Cash Flows, and Stockholders Equity. The statement of Stockholders Equity is not as prevalent as the other three. In this article we will have a closer look at the Income Statement.
The Income Statement (sometimes also called the P&L – Profit and Loss statement) is the financial statement that answers one of the most fundamental questions when evaluating a business’ performance- did the business make any money? The income statement reports on all the sales made, the costs of selling the products (or costs incurred in providing the service for service based companies), other expenses incurred in running the business, and the amount of tax the company paid (if any) during a specific period.
Companies usually issue financial statements every month, quarter and year. However each financial statement has a different time frame. The income statement reports on activities occurring during a specific period. For example Company A could produce an income statement for the first quarter of 2011 detailing (and summarizing) all sales, cost of sales and other expenses only for the months of January, February, and March. It is also common to find income statements with the two prior accounting periods included to give the stakeholders some perspective on the figures being reported. In this case a monthly income statement would show the current month being reported and the two prior months, while a quarterly report would show the current quarter and the two prior quarters and so on. Without this extra information it can be quite cumbersome to detect trends.
Now that we have a basic idea of what the income statement is and its purpose, let us take a closer look at some of the key parts. This article is only meant to take a high level look and will not go into all the nitty gritty details. There are five major areas in an income statement.
Sales (income, revenue)
The money that a company makes by selling the products or services within that period. This is simply a total of all the revenue accounts of the business.
Cost of Goods Sold
This is normally found in the financial statements of merchandising companies but it is increasingly found in service based companies as well. This figure is the total amount spent within that period to purchase or manufacture products (or provide services) that were then sold.
This figure is simply the Revenues minus the Cost of Goods Sold. In other words we subtract the cost of the products or services from how much we sold them for. This figure does not include operating expenses or taxes. In some finance books this is sometimes referred to as EBITDA (earnings before interest, taxes, depreciation and amortization).
This figure details all amounts spent on expenses that were not directly related to the product or service. Salaries, marketing (including advertising), interest on loans, and other overhead expenses come into this category.
Net Income (or Loss)
This figure lets stakeholders know whether the company made a profit or loss for that period. We calculate this by subtracting the Operating Expenses from Gross Profit.
There a few other features of the income statement but they are out of the scope of this article. We will cover them in detail in a later article. But if you’re feeling curious, you can look into taxation, and distribution of income into the equity.