The income statement is among the key financial statements along with Financial Postion Statement and Cash flow stataement which the organizations and businesses prepare for reporting the profit or loss of the organization. The income statement is also called a profit and loss statement.
income statement provides detailed information about the revenue and expenses of any business. This statement has huge importance for both the investors and the management of the organization. It is compulsory for every business to create this statement so that the profit, sales, and expenses of the corporations can be recorded efficiently.
There are certain rules and regulations for preparing this statement. The accountants prepare this statement after gathering all the important financial data.
Importance of income statement
As mentioned earlier income statement has huge significance for the stakeholders of the corporation. The management of the corporations needs an income statement so that they take various financial decisions.
If the corporation has to invest in any project the first thing that they will do is to evaluate the income statement so that they can know whether they have the financial resources to invest in certain projects or not.
see also consolidated financial statements
The investors who want to invest in any business also evaluate the income statement of the business to get an idea about the profitability of the business.
Investors want to gain a significant return on their investment and it is obvious that the company that is generating profit will be the one that can provide a significant return.
The companies that are not generating profit do not provide higher returns on the investment.
Income statements can be used by the management to have an idea regarding its sales. The past figures of sales can be used for estimating future sales. The corporations also evaluate the income statements so that they can manage their expenses more efficiently. Through evaluating the expenses the business can have an idea of its expenses and after evaluation, the businesses can create strategies to mitigate their expenses.
Components of the income statement
The income statement consists of two major sections. One is the revenue section and the other is the expenses section. When the expenses are subtracted from the revenue of the business gets the figure of profit or loss.
The first figure in the income statement is the number of sales or revenue which is generated by the business. The sales figures are the ones who allow the business to earn income. From the sales figures, costs of sales are subtracted to get the figure of gross profit. Cost of Goods Sold or COGS are the expenses which are incurred for selling the goods and services. Gross profit shows how much profit the business is generating after subtracting the cost of sales. From this figure, all the operating expenses are subtracted.
Operating expenses are the expenses that are incurred in the operations of the business. These are routine expenses that are performed by the business so that the day-to-day activities of the business can be performed.
Operating expenses include research and development expenses, selling expenses, general and administrative expenses. The operating expense amount is subtracted from the gross profit amount to get operating income or loss.
Usually, the corporations who want to reduce their costs or expenses reduce the operating expenses of the business. By mitigating the operating expenses the business can increase its profitability.
From the figure of Operating income or loss, the amount of interest expense and tax is deducted. Tax is deducted according to the rules set by the taxation authorities. Apart from interest and tax other expenses are also deducted (if any) from the operating income figure.
Management of the expenses is highly important for the corporations because if the expenses are not going to be accurately managed then huge problems can immerge in the corporations. Therefore it is recommended to the businesses to keep on monitoring the expenses so that they can be managed appropriately.
After subtracting the tax and interest expense from operating income the amount of Net income is generated. This is the amount that indicates whether the corporation is generating income or loss. From net income, the shareholders receive the dividend. The higher the profit the better will be for the corporation.
Income statement example
The following is the example of an Income statement: