As promised in the preceding blog, a critical understanding of the major financial statements is necessary for informed decision-making by managers. However, this blog would focus on an in-depth analysis of the income statement. This is important because the income statement provides a better understanding of the revenue and expenses that impacted the retained earnings on the balance sheet.
The income statement otherwise referred to as the statement of profit or loss and other comprehensive income is used in reporting the financial performance of a company over an accounting period. It provides details on the revenue and expenses during the period under review. This information is very useful for investors, government, creditors, and customers because it reveals the financial health of the company and supports decisions they make regarding the company.
An accounting period is usually a fiscal year- an annual reporting period. It could also be reported biannually, quarterly, or even monthly.
What is Revenue?
Revenue refers to the income derived from selling goods and or services to customers. In simple terms, this is the amount of money realised from doing your business. The amount of money here does not always refer to cash only. Sometimes you may not receive cash immediately but a promise to pay later. This is premised against the realisation concept which relies on two principles- goods and services delivered and the certainty that it will be paid for.
What is Expense?
This refers to all the costs of doing business. Thus, expenses must occur for the company to continue operating. These are simply the resources that the business has used up during the accounting period. For example, salaries, rent, utilities, and transportation amongst others. These are operating expenses.
These are all the expenses incurred while doing the business except the interest expense which is a financing portion of the account. Hence, the interest expense is often listed separately (at the end of the statement). Sometimes expenses are not paid in cash or paid immediately.
Other important terminologies used in the income statement are Cost of Goods Sold (COGS), Gross Margin, Operating Income/Expense, Interest Expense, and Net Income.
Cost of Goods Sold
This refers to the cost to the company of providing the goods sold. It can also be called Cost of Sales where the company is involved in service rather than product sales. For example, a law firm or a restaurant which provides law and catering services. It is an expense item. Having a cost of goods sold account would depend solely on the nature of the company.
This refers to the amount of sales revenue that remains after removing the cost of goods sold. It can also be calculated as a percentage of revenue. Information from the Gross can sometimes be used to make comparison with similar companies and gain an understanding of how well they are managing their cost of production.
Income before and after-tax
Income before tax is the amount remaining after deducting all expenses prior to tax from the revenue derived
While income after tax refers to the income after the deduction of all taxes from the revenue
This is the eventually income derived after all expenses- operating, interest and tax have been deducted. The net income does not always tell the full financial story of the company. A more reliable predictor of financial performance is the Return on Asset or Return on Equity. The Return on Assets or Equity is calculated by dividing the net income by the total asset or equity respectively.