Income Statements: A Comprehensive Guide

To prepare an income statement, businesses must analyze and report their revenues, operating expenses, and the resulting gross profit or losses for a specific reporting period3. The statement shows how the revenues are transformed into net profit3.

Investment analysts often scrutinize companies’ income statements. Equity analysts are interested in them because equity markets often reward relatively high- or low-earnings growth companies with above-average or below-average valuations, respectively1. Fixed-income analysts examine the components of income statements, past and projected, for information on companies’ abilities to make promised payments on their debt over the course of the business cycle1.

The income statement includes several components: revenue; cost of sales; sales, general, and administrative expenses; other operating expenses; non-operating income and expenses; gains and losses; non-recurring items; net income; and EPS1.

Revenue is recognized in the period it is earned, which may or may not be in the same period as the related cash collection1. The cost of goods sold includes the direct labor, materials, and overhead operating expenses incurred to provide goods or services. Subtracting the cost of goods sold from the revenue gives the gross margin.

Operating expenses are the costs associated with the day-to-day operations of the business. Subtracting these from the gross margin gives the pre-tax operating income3. After accounting for income taxes, we arrive at the net income.

Understanding income statements can seem daunting, especially for those new to business finance. However, with a bit of practice and patience, anyone can learn to read and analyze these critical financial documents. By doing so, you can gain valuable insights into a company’s financial health and make informed decisions that can lead to business growth and success.

The income statement is just one piece of the financial puzzle. It should be used in conjunction with other financial statements like the balance sheet and cash flow statement to get a comprehensive picture of a company’s financial health.