Paid non-client promotion: Affiliate links for the products on this page are from partners that compensate us (see our advertiser disclosure with our list of partners for more details). However, our opinions are our own. See how we rate investing products to write unbiased product reviews.
- An income statement is a financial document that details the revenue and expenses of a company.
- Some investors and analysts use income statements to make investing decisions.
- The income statement, along with additional financial documents, is required to be filed with the Securities and Exchange Commission (SEC).
An income statement is one of three major financial statements used to evaluate the health of a company, along with the balance sheet and cash flow statement. There are several terms you'll need to understand in order to know how to read an income statement.
What is an income statement?
An income statement is a financial statement that outlines a company's gains, losses, revenue, and expenses during a specific period.
Also called a Profit and Loss (P&L) Statement or a statement of revenue and expense, the income statement is one of three major documents, along with the cash flow statement and the balance sheet, that provide information on a company's financial results during a specified time frame.
Key components of an income statement
There are several key components of an income statement, and knowing them can go a long way toward helping you interpret one of these documents effectively.
Revenue
Revenue is the amount of money the company brought in during the reporting period. With revenue, it may be important to note any trends to determine whether the company is making more money over time or if sales are slowing down.
Expenses
This section, crucial to analyzing an income statement, details how much the company has spent. Similar to revenue, it may be important to note trends to see if the company is spending more or if they're becoming more efficient over time. When looking at expenses, "We should consider whether the expenses grow in proportion to revenue and the drivers of these expenses," says Patrick Badolato, PhD, CPA, an associate professor in the accounting department at the McCombs School of Business at the University of Texas.
Expenses can include many different line items, for example interest paid on debt, depreciation and amortization, rent and overhead, as well as money paid toward salaries and benefits.
For the sake of clarity, depreciation is an accounting measure to account for the cost in the loss of value for tangible assets of the company, whereas amortization is an accounting technique to lower the book value of debt over time.
Expenses also include cost of goods sold (COGS), which is the amount spent on the production of the products or services sold. For a company like Apple, it would include the glass to make the phone screen or the chips that go into the iPhone.
Other costs that would be counted under expenses would be operating and non-operating expenses. Operating expenses are the cost to bring the product to the market. This could include things like marketing, payroll, and overhead expenses, such as insurance and rent. Non-operating expenses could include things that do not directly relate to core business functions. It may include things like contributions to pension plans or dividends to shareholders.
Another major consideration is taxes, which of course cuts into any financial results a company generates.
Net income
Net income represents the total income left over after all deductions and expenses, including taxes, have been taken out. This is the last line on the income statement, frequently referred to as the bottom line, and it tells you what a company's profit or loss was during a specific time period.
Why income statements matter
The income statement is important for a wide range of parties, including investors and people responsible for running a company (its executives and managers).
"The income statement should be used by anyone trying to understand the business conducted as well as the profitability of a company," says Badolato.
Assesses profitability
One simple way an income statement can come in handy is by providing a sense of just how profitable a company really is. Is the company in question making money?
Income statements can help answer this question, along with providing some excellent insight into why, exactly, a company is experiencing its current financial performance.
Informs business decisions
By reviewing a company's income statement, you can quickly pinpoint areas that have room for improvement. For example, a company could cut costs in one area and put more money into others, such as sales and marketing, that could potentially fuel expansion.
Attract investors
Investors may use income statements, along with other financial statements, to make investing decisions and determine the financial health of a company.
For example, an increasing amount of sales from year to year might be attractive for a potential investor and can be found in the first line of an income statement. Conversely, if costs are rising this can also be seen on the income statement and may lead an investor to ask more questions about the long-term profitability of the company.
Investors and financial analysts also use the income statement to derive popular financial ratios like Earnings Per Share (EPS).
Earnings per share is a measure that compares a company's net income compared to the outstanding shares. The price-to-earnings ratio, or P/E ratio, is another commonly used metric that factors in the company's stock price in relation to EPS. When comparing companies, EPS and the P/E ratio can help differentiate two companies in the same category and help an investor make a more sound investing decision, but both use information provided through the income statement.
"The equation driving the Income Statement is: Revenues – Expenses + Gains – Losses = Net Income," says Badolato.
Income statements are also important to regulators. All public companies are required to file a Form 10-K each year with the Securities and Exchange Commission (SEC) and Form 10-Q each quarter which include the income statement and other financial documents and disclosures.
Income statement analysis
When analyzing income statements, there are two primary methods that are used: vertical analysis and horizontal analysis.
Vertical analysis shows each item on a financial statement as a percentage. An example of this would be the COGS expressed as 35% of the total revenue. This type of analysis can be useful when comparing with other companies in the industry.
Horizontal analysis is used to review a company's performance over two or more periods by stacking each line item directly next to each other from the previous period. Instead of looking at one income statement at a time from different periods, horizontal analysis compares them side-by-side in one view.
How to read an income statement
Below is the 2021 quarterly income statement from Ford's Form 10-Q. One of the first things that you will notice is that the report is using horizontal analysis. This is because the report is comparing the second quarter of 2020 to the second quarter of 2021 as well as the first half of 2020 and the first half of 2021.
In the first section under Revenues, you'll see each of Ford's major revenue streams, including car sales under Automotive, Ford Credit, and Mobility. In the notes section of the 10-Q, the Mobility line refers to Ford's autonomous vehicles and related business as well as its equity stake in Argo AI.
Next in the cost and expenses section, you'll notice where Ford is spending its cash. The bulk of those expenses fall under cost of sales, which is another name for the cost of goods sold. You can also see that costs have increased from the second quarter of 2020 to the second quarter of 2021 resulting in a net income of $561 million during the second quarter and $3.8B during the first half of 2021 in the final column on the right.
Income statement vs. balance sheet
Both income statements and balance sheets provide important details about how a company uses its cash and other assets, but there are a few key differences between the two.
Think of an income statement like a financial timeline, whereas a balance sheet is a snapshot at one point in time. This is because income statements provide details on the amount of money made and spent during a period. The income statement essentially answers the following questions: How much money did the company make? How was that money spent? Did the company make a profit?
The balance sheet, on the other hand, tells you how much the company has in assets, liabilities and shareholder's equity. The balance sheet follows a simple formula:
Asset = Liabilities + Shareholder's equity
Like the name mentions, the figures on the balance sheet must match as any increases or decreases must be offset. Unlike the income statement, it does not provide information on how much money the company has made or lost, it only provides the amount of debt, cash and other assets that the company owns at that point in time.
While these financial statements are different, both the income statement and balance sheet along with the cash flow statement are still linked and should be used together to determine a more holistic financial picture of a company.
| Income statement | Balance sheet |
|
|
Income statements: Conclusion
The income statement is a good entry point to understand and evaluate a company's revenue and costs, but it's important to keep in mind that it's not a document that can tell the full story.
"Financial statements are designed to work as a system and not as stand-alone statements," adds Badolato. "The Income Statement is only one piece in understanding the financial performance of a business. Using one financial statement without the others and other publicly available information — such as the footnotes in a financial filing — would be similar to betting before looking at one's cards."
FAQs
The frequency can vary, but usually, companies prepare income statements either quarterly or annually.
An income statement shows a company's financial performance during a specific time frame, whereas a balance sheet shows a company's assets and liabilities at one point.
Companies release income statements in their financial reports, and you can also find them on the investor relations sections of corporate websites.
An income statement can display a negative net income, which indicates that a company suffered a loss during a specific period.
You can use the information on an income statement to calculate key ratios like gross margin, operating margin and earnings per share.
Reference
