The Income statement : Basics

MANY NAMES OF INCOME STATEMENT

we know that the income statement shows revenues, expenses and profit for a period of time, such as month, quarter or year. Accountants call these statements by different names –

  1. Profit and loss account or just ‘P & L’
  2. Income statement
  3. Trading and profit and loss account
  4. Statement of income/revenues
  5. Statement of operations
  6. Operating results statement
  7. Statement of operating results
  8. Statement of earnings
  9. Earnings statement
  10. P & L statement
  11. Statement of financial performance..etc


WHAT’S IN A NAME?

We cannot say that it’s the accountants call to put any name he likes. These statements assume different names according to the nature of business of the company. For example a company that has no trading activity ( buying and selling of goods) or a company involved in service oriented industry, will not have a trading and profit and loss account simply because, there is no trading activity involved. So a company like Infosys will have an income statement or a statement of revenues or a profit and loss account and a company like Reliance will have a trading and profit and loss account.

In any case, the income statement displays the profit made. However, in the case of companies involved in trading, it makes two types of profits called -

  • Gross profit and
  • Net profit.

Gross profit is the profit made from sales before deducting running expenses. The only item deducted from sales is the purchase cost of goods that was sold. The purpose of tracking gross profit is to know the actual trading margin in the business. It’s important for companies to see that the percentage of gross profit never falls.

Net profit is what the company makes after deducting all types of expenses. So, if the net profit falls, that means that somewhere the cost of operating the business has increased.

In the case of companies not involved in trading, the Gross profit element will be missing in the income statement. Only the net profit will be shown. In fact, there is no gross profit for them – since their business do not involve buying something for a lesser price and selling it at a margin.

So, income statement will be prepared according to the nature of business and an appropriate name will be given that matches with the nature of business.In the case of a trading company, the income statement will show the gross profit and net profit separately.

MANY FEATURES OF INCOME STATEMENT

That’s not all. The income statement has many more features. Here’s a point wise collection will help you to understand the income statement better.

  • The format can be vertical or horizontal: Generally, the income statement is drawn in a vertical or horizontal format. In which ever way it’s drawn, the first item in it would be ‘revenues’ or ‘sales’. This sales figure appearing on top of the statement is also called ‘top line’ of the business. (Hope you’ve heard of analysts taking about the increase/decrease in ‘topline’ of the company). In vertical format, each and every expense is deducted from the revenue figure and finally the net profit is arrived at.  This net profit is also called ‘bottom line’ in financial lingo since it appears as the last item in the income statement. In the horizontal format, the sales or revenues are shown on the right side and categorized expenses are shown on the left side and the difference between the two will be shown on the right side ( loss) or left side ( profit).Charitable organizations / clubs / non profit making voluntary organizations / association of persons that exist for the welfare of the society etc- may not have an income statement or revenue statement since they do not exist for making revenues. However, these organizations do have money flowing in the form of contributions. Hence, they prepare a statement called ‘receipts and payment account’ and the resultant surplus money will be termed as ‘excess of revenue over expenditure’.Which ever way it’s presented, the basic idea of a revenue statement is to arrive at the profit. The form is not important.
  • The time period – you cannot draw a revenue statement unless you decide about the time period for which it is drawn. For example – you can find the revenues, deduct all the expenses and arrive at the net profit for a year, for six months, for a quarter, for a month or even for a week. The time period has to be decided. Corporates prepare revenue statement for all quarters and of course, the official annual report.
  • Projected and estimated statements: Accountants also prepare ‘projected financial statements’ which shows the expected revenues and expenses in the coming years if the current trend continues. Accounting projections may be made for 5 or even 10 years forward depending on the use intended. Estimated financial statements are sometimes prepared to know the expected profits for the current year if the current trend continues. Projections are basically estimates.
  • Stand alone and consolidated statements : Big companies (For example – Tata group) which has many subsidiary companies under it’s control may publish ‘consolidated financial statements’ to show the consolidated figures from all it’s businesses. Such business conglomerates will also have stand alone statements for each of their firms.
  • Provisional and audited statements: In India, The companies Act and the Income tax Act requires companies to get their financial statements audited by professional accountants. A financial statement that’s not audited is called ‘provisional financial statements’ and the one that’s audited is called audited statements. What’s important for an investor is to look at the audited financial statements. Audited financial statements are included in the annual report and that is the final –official- legal – profit and loss statement of the company. The audited financial statements will be made available to the share holders of the company. The audited statements of all the companies listed in the stock exchange are available in the stock exchange’s website or various financial sites and newspapers.

CONCLUSION

The income statement is one of the three statements that a stock market investor should be familiar with. What’s important for an investor is to have a look at the audited financial statements. Projections, estimates or provisional statements are made for different purposes and involves a lot of assumptions.

Even the actual financial statement we are talking about is not free from assumptions and estimates. To understand how income statements are made , we need to look at an important concept in accounting- called the ‘matching concept’.

More about matching concept in out next post.

You may like these posts:

  1. The components of financial statements
  2. Introduction to financial statements
  3. How to read an Annual report.

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