Income Statement: How to Read and Use It?

Among all the financial statements that hold significance, an Income statement is the most vital. Whether you’re an investor, analyst, or business owner, knowing how to read and use an income statement can provide valuable insights into a company’s operations and help you make informed decisions. 

With that said, let’s delve into the guide below, where we define an income statement, how to prepare one with an income statement example, what information an income statement provides, and more.

What Is an Income Statement?

An income statement, also called a profit and loss statement, shows a company’s financial health by detailing its revenues, expenses, and overall profitability over a specific period. 

It is a summary that breaks down the money a company made, the costs it incurred, and what it ended up with a profit or loss. This financial document outlines a company’s expenses, revenues, and profits over a specific period of time, typically a year. 

Most portfolio management services providers use it as a primary statement to determine the potential of the company. 

Key Components of Income Statement

Revenue and Gains

Revenue is the total amount of money received from the company’s main activities, such as selling products or providing services, before any costs or expenses are deducted. On the other hand, revenue can also be generated from secondary activities like selling business assets or from other non-business operations.

For a retail store, this would be the income from selling clothes; for a consulting firm, it’s the fees earned from providing advice. The businesses maintain revenue statements for recording all such income. To generate additional investment revenue, you can always take the guidance of a SEBI-registered advisory.

What Is the Difference Between Operating Revenue and Non-Operating Revenue?

Aspect	Operating Revenue	Non-Operating Revenue
Definition	Income generated from a company’s core business activities.	Income from activities not related to the company’s main business operations.
Source	Sales of goods and services directly related to the company’s primary business operations.	Investments, sale of assets, or interest received.
Frequency	Regular and ongoing, as in the revenue statement.	Irregular and not expected to occur all the time.
Example	Revenue from product sales for a manufacturing company.	Profit from the sale of a building or earnings from investments.

Expenses

Expenses are the costs incurred in earning the primary revenue. They are the “Unavoidable costs” of running a business. Expenses include selling and distribution expenses, administrative expenses, general expenses,, and the cost of goods sold (the direct costs of producing the products sold).

Gross Profit

Gross profit is the amount of money a company makes from its sales after subtracting the direct costs associated with producing or acquiring the goods sold. 

Net Income

Net income, also known as profit or net earnings, is the total amount of money a company earns after deducting all expenses from its total revenue.

Income Statement Example Structure

Here’s how to prepare an income statement:

Components		Amount (₹)
Revenue
	Sales	50,000
	Revenue from Workshops	8,000
	Cost of Good sold	(30,000)
Gross Profit		28,000
-Expenses
	Wages	(7,000)
	Rent	(6,000)
	Utility	(5,000)
		(3,000)
= Net Income = (Revenue Expenses		7,000

What Insights Should You Look for in an Income Statement?

1. Revenue Trends: Is the company growing? Look at the revenue in the income sheet over multiple periods. Increasing revenue is a good sign, indicating that the business is selling more of its goods or services.
2. Profit Margins: How much of the revenue is left after covering expenses? Check both the gross profit margin (after COGS) and net profit margin (after all expenses) in the income sheet. Higher margins suggest better efficiency and profitability.
3. Expense Management: Are operating expenses under control? A well-managed company keeps its expenses in check as it scales. To lessen this component, the company can always choose to opt for tax-saving investment options.
4. Non-Operating Items: These can include interest income or expenses and one-time gains or losses. They’re worth noting because they can significantly impact the bottom line but might not be repeatable in future periods.
5. Net Income Growth: Ultimately, is the company becoming more profitable? The outcome figure shows the company’s earnings after all expenses. Growing net income is a strong indicator of a company’s financial health.

Uses of Income Statements

1. Checking the Company’s Performance: At its core, the income statement lets you see how a company is performing. It breaks down revenues, expenses, and profits, giving you a brief on operational efficiency and profitability.
2. Trend Analysis: By comparing income statements from different periods, you can identify trends in revenue, costs, and net income. This helps in understanding the company’s growth trajectory and operational performance over time.
3. Decision Making: Income statements can help you make informed decisions about budgeting, investing in new projects, cutting costs, or expanding operations. They also guide strategic planning and resource allocation.
4. Investor Analysis: You can rely on income statements to assess a company’s financial viability and potential for future growth. Key metrics like revenue, net income, and earnings per share (EPS) influence investment decisions.
5. Lending Decisions: Lenders examine income statements to evaluate a company’s ability to generate profits and manage expenses, which affects its capability to repay loans.
6. Benchmarking: Businesses define income statements to benchmark their performance against industry standards or competitors. Comparing key financial ratios and metrics helps identify strengths, weaknesses, and areas for improvement.
7. Interest and Taxes: After operating income, we consider any interest expenses from loans or interest income from investments. Then, we account for taxes owed to the government. 

Conclusion

Income statement  elements are crucial as per income tax concepts because they show the impact of financing and tax obligations on the company’s profits. By understanding and utilizing the information provided in an income statement, stakeholders can make informed decisions regarding investments, budgeting, and strategic planning. 

 Frequently Asked Questions