Income Statement

Income Statement, one of three main financial statements, shows a company's revenue, expenses, and profits. Learn the definition, components, and see examples.

What is an Income Statement?

The Income Statement is one of the three main financial statements, along with Balance Sheet and Cash Flow Statement. It shows all revenues, expenses, and profits in a specific accounting period of time.

The Income Statement could also be called Profit and Loss Statement (P&L Statement), Statement of Comprehensive Income, Statement of Earnings, Earnings Statement, or Statement of Operations.

The income statement is one of the three main financial statements. It shows all revenues, expenses, and profits for an accounting period.

There are several variations of the income statement depending on the specific line items that a business might have.

For instance, all of the variations have revenue (also called sales) but there could be different revenue subtypes based on different payment types (subscription revenue vs. transactional revenue) or product lines (car parts revenue vs. technician labor revenue).

At the bottom of the statement, a net profit or net loss number is reported. A net profit is shown if revenues are larger than expenses, a net loss is shown if revenues are less than expenses. We will explore this below in our income statement examples.

Income Statement Formula

The income statement formula is net income = revenue - expenses.In other words, the revenue you earned in this period minus all of the associated expenses will result in a net income or a net loss (if your expenses are more than your revenue).

In fact, the entire income statement acts like a giant formula in order to understand if a company made a profit or had a loss in the period. We are going to show the income statement template below and highlight key sections.

Income Statement Template

Total Revenue = The sum total of all revenue generated by selling products or rendering services; also called Total Sales
Cost of Goods Sold = The direct labor and material costs associated with selling your product or service; often abbreviated as COGS
Gross Profit = The profit left after deducting the direct costs; total revenue less COGS
Operating Expenses = The expenses incurred during the normal course of business including advertising, rent, utilities, salaries, legal fees, insurance fees, taxes, etc.; since this is a large category, it’s often broken out into subcategories; referred to as OPEX
Net Operating Income = The profit (if any) left over from the regular operations of a business
Non-Operating Revenue = Irregular or one-time revenue generated, income outside of core business activities; examples include dividend income, gains from investments, and gains from foreign exchange
Non-Operating Expenses = Irregular or one-time expenses incurred, expenses outside of core business activities; examples include interest expense, lawsuit settlements, losses from asset sales, losses from investments, and losses from foreign exchange
Net Income = What is left after all revenues and expenses are tallied; also called net profit or bottom line

Now that we have the definitions, we can put it all together…

Total Revenue: $500,000

less Cost of Goods Sold: $220,000
equals Gross Profit: $280,000
less Operating Expenses: $200,000
equals Net Operating Income: $80,000
plus Non-Operating Revenue: $5,000
less Non-Operating Expenses: $3,000
equals Net Income: $78,000

The business ended up with $80,000 of profit during its normal course of business operations, and had minimal non-operating charges, ending up with a bottom line of $78,000.

Types of Revenue

To build a viable company, you need to generate revenue (also called sales). However, there are several options to break down revenue that can help to understand how a company is performing.

Gross Sales: The total of your sale transactions in a given period
Net Sales: The sales left after backing out returns, allowances, and discounts; Net Sales is usually reported on the Income Statement
Sales by Category: For companies with multiple products or services, it can be helpful to group sales by category to understand growth and profitability per
Sales by Region: For companies that sell to multiple states, regions, or countries, isolating sales by geographic region can provide useful insights

Types of Expenses

Expenses are the costs incurred when running a business. All businesses have basic expenses, like marketing expenses, wages for workers, taxes, fees, and more. However, how you categorize expenses will have a large impact on your accounting ratios.

Cost of Goods Sold (COGS): Direct costs, like director labor, materials, and attributable overhead to sell your products or perform your services
Operating Expenses (OPEX): Normal business expenses not connected to your sales, like salaries, legal fees, insurance costs, rent, utilities, and marketing
Non-Operating Expenses: Irregular or one-time expenses that happen outside of the course of your normal business

For instance, when building financial models, people often forget to include income tax expenses when thinking about how much money they will have left at the end of the day. Income taxes can fluctuate from 0% to 30%, depending on your region, and can have a large impact on your performance.

In addition, you should also consider the timing of expenses as you may have to pay upfront for some expenses for the year while others you have to pay monthly or in arrears (the invoice is sent after work is completed).

Types of Profit

There are also several times of profit, so it is important to clearly define what you mean when you are referring to “profit”.

Net Operating Income: The profit left after your ordinary course of business
Net Income: The profit left after operating and non-operating activity are accounted for; this is a more complete look but can be deceiving if you have large non-operating revenues or expenses in the current period
Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA): EBITDA is a useful metric to understand the underlying health of a business by removing nonessential charges and by backing out non-cash events, like depreciation and amortization
Earnings Before Interest and Tax (EBIT): EBIT includes depreciation and amortization expenses, but not interest expense or taxes payable; another way to assess profit

Income Statement Examples

Here is an example of an income statement for Company A over three consecutive months. As a reminder, there are two types of income statements, single-step and multi-step.

A single-step income statement would lum all of the revenues and expenses together. The example below is a multi-step income statement because we separated non-operating activity from operating activity.

Company A

Month 1

  • Revenue: $500,000
  • COGS: $350,000
  • Gross Profit: $150,000
  • Operating Expense: $90,000
  • Net Operating Income: $60,000
  • Other Income: $0
  • Other Expenses: $10,000
  • Net Income: $50,000

Month 2

  • Revenue: $600,000
  • COGS: $450,000
  • Gross Profit: $150,000
  • Operating Expense: $90,000
  • Net Operating Income: $60,000
  • Other Income: $0
  • Other Expenses: $5,000
  • Net Income: $55,000

Month 3

  • Revenue: $700,000
  • COGS: $480,000
  • Gross Profit: $220,000
  • Operating Expense: $160,000
  • Net Operating Income: $60,000
  • Other Income: $0
  • Other Expenses: $11,000
  • Net Income: $49,000

In the example above, we looked at the P&L and were able to understand whether Company A was profitable and if their profitability has increased or decreased over the three-month period. We saw that revenue grew by 40% but there was no change in net operating income.

Income Statement Metrics & Ratios

The numbers on an Income Statement can be used to determine a company’s financial health and, when taken together over several periods, the financial progress that a company is making.

Here are some useful Income Statement metrics and ratios:

Revenue Growth: By looking at revenue for several periods, we can easily get a sense of revenue growth; usually expressed as a percent for month-over-month or year-over-year
Gross Margin: Gross Profit / Total Revenue; understand how much margin you have left after accounting for direct labor and material costs; a higher gross margin is better
Operating Margin: Operating Profit / Total Revenue; understand how much margin you have at the end of the day; a higher operating profit margin is better
Interest Coverage Ratio (ICR): For companies that take on debt, interest coverage is a key metric to make sure they can easily make their payments; the formula is Interest Expense / EBIT
Return on Equity (ROE): A measure of a company’s annual return; the formula is Net Income / Total Shareholders’ Equity; total shareholders’ equity is found on the balance sheet
Return on Assets (ROA): A measure of a company’s annual return; the formula is Net Income / Total Assets; total assets is found on the balance sheet

These metrics and ratios can be used to determine the viability and health of a business. Metrics should either be stable over time or steadily increasing. Operators and investors would be concerned if there are large swings in margins or financial ratios from quarter to quarter.

Common Size Income Statement

A common size income statement is an income statement where every line item is expressed as a percent of total revenue or total sales. Business operators, investors, and analysts like to use this approach in order to get a sense of how a business is performing period over period.

For example, it can be easier to see if advertising expense grew from 20% to 28% of your revenue by looking at percentages instead of looking at raw numbers – especially if revenue is growing over the periods being analyzed.

Moreover, a common size income statement is a great tool when comparing several companies that are of different sizes. This method puts all companies on equal footing, looking how efficient they are with their spending and diving deep into their margins.

Below, we will look at a regular income statement and a common size income statement for Company A. This is the same information as month 1 above.

Regular Income Statement for Company A

  • Revenue: $500,000
  • COGS: $350,000
  • Gross Profit: $150,000
  • Operating Expense: $90,000
  • Net Operating Income: $60,000
  • Other Income: $0
  • Other Expenses: $10,000
  • Net Income: $50,000

Common Size Income Statement for Company A

  • Revenue: 100%
  • COGS: 70%
  • Gross Profit: 30%
  • Operating Expense: 18%
  • Net Operating Income: 12%
  • Other Income: 0%
  • Other Expenses: 2%
  • Net Income: 10%

A common size income statement expresses every line item as a percent of total revenue.

Note that the first line item when using the common size method is always revenue and will always be 100% (since it’s revenue divided by revenue).

Final Thoughts

The income statement shows a company’s revenues, expenses, and profits/losses. The statement is the foundation for understanding the company’s operations and company’s financial performance. At the bottom of the statement, you arrive at the company’s profit (if revenue less expenses is positive) or loss (if revenue less expenses is negative) for the period.
By contrast, balance sheet lists a company’s assets, liabilities, and equity, and is used to assess if a company can meet its financial obligations. A balance sheet has two sides and they must be equal (hence the name). Both documents are key to financial statement analysis.

The income statement could also be called profit and loss statement, P&L statement, statement of comprehensive income, statement of earnings, earnings statement, statement of operations, or operating statement.

Regardless of what you call it, the formula is the same: net income equals revenue minus expenses.

Business owners, executives, managers, and investors will look at the statement to understand sales, COGS, gross profit, OPEX, and net profit or net losses.

In addition to dissecting the income statement values themselves, there are a number of income statement ratios like gross margin (gross profit divided by net sales), operating margin (OPEX divided by net sales), and profit margin (net profit divided by net sales).

The bottom line is that an income statement is likely the most important accounting statement, as it shows how profitable your business is over a period of time. The income statement is usually reported on a monthly basis, and rolled up to provide quarterly or yearly views as well.

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