Statement of profit or loss reports a company’s performance over a period of time. It lists the amounts for revenues (also called sales) and expenses. Statement of profit or loss is also called income statement. It is prepared to ascertain correct and accurate gross profits or losses and net profits or losses during an accounting period.
Understanding the Income Statement
The statement displays the company’s revenue, costs, gross profit, selling and administrative expenses, other expenses and income, taxes paid, and net profit in a logical way.
The income statement focuses on four key items: revenue, expenses, gains, and losses. It starts with the details of sales, and then works down to compute the net income and eventually the earnings per share (EPS). Essentially, it gives an account of how the net revenue realized by the company gets transformed into net earnings (profit or loss).
Net income reflects the profit (also called earnings) to owners for that specific period.
Manufacturing and merchandising companies typically include an additional expense account, called
cost of goods sold (or cost of sales), in the income statement following revenues. It is also common to report a subtotal called gross profit (or gross margin), which is revenues less cost of goods sold. The company’s remaining expenses are then reported below gross profit. This income statement layout follows:
Operating activities use company resources to produce, promote, and sell its products and services.
These activities extend from input markets involving suppliers of materials and labor to a company’s
output markets involving customers of products and services. Input markets generate most expenses (or costs) such as inventory, salaries, materials, and logistics. Output markets generate revenues (or sales) to customers. Output markets also generate some expenses such as marketing and distributing products and services to customers. Net income arises when revenues exceed expenses. A loss occurs when expenses exceed revenues. Differences exist in the relative profitability of companies across industries.
Income Statement Structure
The formula for calculating Net Income is based on the following:
Net Income = (Revenue + Gains) – (Expenses + Losses)
Single-Step Income Statement
A single-step income statement offers a simplified view of a company’s revenue and expenses. It is a straightforward document that conveys a company’s revenue, expenses, and bottom-line net income. All revenues and gains are totaled at the top of the statement, while all expenses and losses are totaled at the bottom. This simplified approach makes record-keeping easier for both the accountants who prepare the statements and the investors who read them. Shareholders need only focus on the net income figure, to gauge a company’s overall vitality.
Multiple-Step Income Statements
Multiple-Step statements provide an in-depth look at a company’s financial health, offering details about the company’s wellbeing. It categorizes expenses as either direct costs (also known as non-operational costs), or indirect costs (also known as operational costs). Direct costs refer to expenses for a specific item, such as a product, service, or project. Contrarily, indirect costs are generalized expenses that go towards a company’s broader infrastructure, and therefore cannot be assigned to the cost of a specific object. Examples of indirect costs include salaries, marketing efforts, research and development, accounting expenses, legal fees, utilities, phone service, and rent. It segregates the operating revenues, operating expenses, and gains from the non-operating revenues, non-operating expenses, and losses, and offer many more details through the income statement. Essentially, the different measures of profitability in a multiple-step income statement are reported at four different levels in a business’ operations – gross, operating, pre-tax and after-tax.
Example of an Income Statement
In my my next post, will be the Statement of Stockholders’ Equity.