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Posted on 15 October 2024
Author : Enerpize Team

How To Read an Income Statement: A Comprehensive Guide

What is an Income Statement?

The income statement records a company’s revenue, expenses, gains, and losses over a given reporting period. Also known as a Profit and Loss (P&L) statement, income statements provide detailed information about a company’s overall operational efficiency, management robustness, and cost management effectiveness.

As such, income statements are indispensable for all stakeholders to obtain a comprehensive picture of a given company over a specific reporting period. No financial statement can provide detailed information about a company’s revenue, expenses, gains, and losses as income statements do.

Given how vital income statements are, how do you analyze and read an income statement as a business owner or executive manager?

But first is first. You first need to learn what an income statement is made up of.

Income Statement Components

Typically, an income statement is made up of six components:

Operating Revenue.
Non-Operating Revenue.
Gains.
Primary-Activity Expenses.
Secondary-Activity Expenses.
Losses as Expenses.

The following is a more detailed discussion of each.

Operating Revenue

Operating revenue refers to all revenue a company realizes—in cash, non-cash, or cash equivalents—from direct or primary business activities. For example, if a company sells products or services, revenues generated from such sales are considered operating revenue.

Non-Operating Revenue

Predictably, non-core or indirect business activities are considered non-operating revenue. Indirect business activities that result in income generation include:

Interest on bank-deposited capital.
Property leasing.
Mergers and acquisitions.
Royalties and licensing.
On-property advertising.
Interest on dividends.

Depending on size and scope, non-operating revenue could surpass operating revenue, particularly for global companies like Apple.

Gains

Also called sundry or miscellaneous income, gains are a company's revenue stream from selling long-term assets. Unlike non-operating revenue, which is recurring, gains are usually one-time non-core business activities. These include selling property, equipment, or an affiliate subsidiary or practice.

However, a distinction should be made between revenue as a stream of income and receipt as evidence of income. In essence, revenue is a promise made (but which has yet to be fulfilled) to pay a company in return for products or services purchased. However, a receipt is evidence of a reported payment where money is actually received. A seller may, for example, issue a debit note to a buyer who is yet to pay later, depending on his credit reputation.

Primary-Activity Expenses

These are expenses a company incurs to generate primary activity or operating revenue. Generally, primary-activity expenses include COGS, depreciation or amortization, R&D, and selling, general, and administrative (SG&A) expenses. Common examples include:

Payroll
Lease
Utilities
Repair/Maintenance
Taxes
Travel
Accommodation

Secondary-Activity Expenses

These are mirror records of non-operating revenue. That is, while non-operating revenue records revenue streams from non-core business activities, secondary-activity expenses record expenses from non-core business activities, such as interest on loans or debt.

Losses as Expenses

These are mirror records of gains. That is, while gains record revenue a company realizes from selling long-term assets, usually on a one-time basis, losses as expenses record expenses a company incurs from assets sold at a loss, also usually on a one-time basis. Further, losses as expenses may include unexpected or unusual costs, such as substantial property damage or litigation costs.

Now that you have learned what an income statement consists of, a next intuitive step is to learn how to analyze one.

Income Statement Analyzing

The income statement is created mathematically using a standard formula as follows:

Net Income = [Revenue + Gains] - [Expenses + Losses]

That is, a company’s net income is calculated by subtracting all outgoing costs (expenses + losses) from incoming income (revenue + gains), where “Revenue” refers to operating and non-operating revenue and “Expenses” refers to primary-activity expenses and secondary-activity expenses.

What follows is an account of various methods used to calculate a company’s net income.

Vertical/Horizontal Analysis

Vertical Analysis

The vertical analysis method lists each line item as a percentage of a reference, or base, figure within a current reporting period. Instead of listing line items as actual values, income statements created using a vertical analysis present numbers as percentages of gross sales.

The vertical analysis method helps compare a company’s financial statements over a given reporting period, across industries, and between companies, but it cannot readily provide financial planners, controllers, and auditors with immediate financial information as a horizontal analysis does.

Horizontal Analysis

In contrast, a horizontal analysis lists each line item in an income statement as a percentage of a reference figure across multiple reporting periods. Unlike a vertical analysis, a horizontal analysis approach to financial analysis is consistent with GAAP requirements.

Horizontal analysis is more important for financial planners and investors than vertical analysis. Specifically, a vertical analysis provides senior internal financial controllers and external analysts with market-wide comparisons between a given company and comparable companies over multiple reporting periods.

Alternatively, a company’s net income can be accounted for using single-step and multiple-step methods as follows:

Single-Step/Multiple-Step Method

Single-Step Approach

The single-step method is done as shown above by adding all revenue, gains, expenses, and losses.

Multiple-Step Approach

The multiple-step method involves more complex calculations, where revenue, gains, expenses, and losses are much more diversified. The profitability of big companies or companies operating globally is typically reported in four phases: gross, operating, pretax, and post-tax. This four-phased profitability calculation helps break down all components into more manageable and analyzable accounting activities.

That said, how could you eventually read an income statement as in real business situations?

How to Read an Income Statement?

A practical example is needed to show you how to read an income statement. Here is one:

Category	Amount ($)
Revenue
Sales Revenue	500,000
Other Revenue (e.g., interest)	10,000
Total Revenue	510,000

Cost of Goods Sold (COGS)
Raw Materials	120,000
Labor Costs	80,000
Manufacturing Overhead	50,000
Total COGS	250,000

Gross Profit	260,000

Operating Expenses
Selling Expenses	30,000
General & Administrative	50,000
Research & Development	20,000
Total Operating Expenses	100,000

Operating Income	160,000

Other Income & Expenses
Interest Income	5,000
Interest Expense	(3,000)
Net Other Income/Expenses	2,000

Income Before Taxes	162,000

Income Tax Expense	(32,400)

Net Income	129,600

The following sections explain how to read each primary section in ABC’s income statement.

Revenue Section

The Revenue Section shows ABC’s gross margin was $260,000 for the fiscal year ending December 31, 2023. This margin is calculated by subtracting the cost of revenue, COGS, ($250,000) from the total revenue ($10,000). That means ABC spent 49% of its total revenue to generate $510,000.

Operating Expenses

Operating expenses are additional expenses ABC incurs and are subtracted from its Total Revenue. Specifically, ABC spent $100,000 on Selling Expenses ($30,000), General & Administrative ($50,000), Research & Development ($20,000). Subtracting ABC’s Operating Expenses ($100,000) from its Total Revenue ($510,000) leads to an Operating Income of $160,000, which is used to calculate ABC’s net income according to the formula as mentioned earlier under “Income Statement Analyzing.”

Other Income & Expenses

These are income ($5000) and expense ($3000) line items from non-operating revenue and secondary-activity expenses. The net of adding both equals $2000 in positive value, as shown next to Net Other Income/Expenses.

Gains & Losses

The above example does not show gains or losses made by ABC. That means our calculation moves on to ABC’s pre-tax income.

Income Before Taxes

This is calculated by adding Net Other Income/Expenses to Operating Income to get ABC’s Income Before Tax of $162,000.

Income Tax Expense

This covers all expenses incurred by ABC to pay income tax, including payroll, sales, and excise taxes. The above example shows an Income Tax Expense of $32,400.

Net Income

This is where ABC’s Net Income can be calculated by subtracting Income Tax Expense ($32,400) from Income Before Taxes ($160,000) to get $129,600.

That said, as companies grow in size and operations, calculating their net income can become more complicated as more entries are accounted for based on broader business activities.

Streamline Income Statement With Enerpize

Enerpize is a leading online accounting software developed with accounting operations management front and center. Opting for Enerpize has helped many companies scale and streamline income statements smoothly, quickly, and compliantly.

With multiple features in place, Enerpize is best positioned to help businesses:

List expenses and revenue from any device or platform anywhere at any time.
Custom-display revenue, expenses, net income, and more to generate shareable and printable invoices, set date ranges, and auto-calculate net profit.
Calculate tax options (GST, VAT, EXP, etc.) per jurisdiction or reporting period.
Track operation expenses to control costs and calculate profitability per product, segment, or department.
Create custom accounts to map a range of transactions onto your general ledger.
Generate lifetime company statements and reports.
Maintain accurate records of all transactions to prepare auditable and reportable financial data for automated or manual statements and sheets.
Auto-adjust Enerpize settings as and when required to create easy-to-generate recurring expense daily, weekly, or monthly records.
Perform cost-effective asset development, operationalization, upgrade, and disposal to enhance asset acquisition.
Use a multi-currency setup to manage payments and comply with tax regulations in multiple jurisdictions.

Try Enerpize out to get your accounting operations management on its feet - and to compete.

Final Thoughts

Income statements are indispensable for every business to calculate, manage, and project revenue, expenses, gains, and losses.

As a business owner or executive manager, you must learn how to analyze and read your income statement - even when you have your in-house accountant.

To analyze an income statement, you may opt for a vertical/horizontal approach where each line item is listed as a percentage of a reference figure within a current reporting period (vertical analysis) or across periods (horizontal analysis).

You may also opt for a single-step or multiple-step approach, in which all revenue, gains, expenses, and losses are added straightforwardly (single-step method), or more complex line items involving a wider range of revenues, expenses, gains, and losses are included (multiple-step method).

The bottom line is, income statements are used not only by immediate stakeholders such as accountants or financial controllers but also by investors, upper management, and creditors to decide on more strategic financial and market matters.

Choose your accounting management partner carefully so your business outperforms the competition.

Reading income statement is easy with Enerpize.