The second type of financial statement is the income statement (also called ‘profit and loss statement’ or ‘statement of operations’). This statement summarizes all revenue, costs, expenses, and profits for a specified period of time, such as a quarter or fiscal year.
Like the balance sheet, the income statement is divided into distinct sections. This is crucial for analysis as well as comparisons between companies.
The income statement can be easily summarized by its major parts and subtotals:
- Minus: Cost of Goods Sold
- Equals: Gross Profit
- Minus: General Expenses
- Equals: Net Operating Profit
- Plus or Minus: Other Income and Expense
- Equals: Pretax Profit
- Minus: Liability for Income Taxes
- Equals: Net Profit
The category of cost of goods sold (also called direct costs) includes all expenditures that are assignable directly to revenue production, including merchandise purchased, manufacturing or production labor (direct labor), freight, and the net change in inventory levels for the year.
The cost of goods sold is expected to rise and fall along with revenue, and the percentage of these costs to revenue is expected to remain fairly constant. Changes may occur as a result of mergers and acquisitions, or disposal of an operating segment, when the mix of products also changes as a result.
When the cost of goods sold is subtracted from revenue, the resulting dollar value is called gross profit. Like the cost of goods sold, gross profit is expected to remain at about the same percentage level of revenue from year to year. This may change due to improved efficiencies, changes in inventory practices or valuation, and changes in market pricing.
Next, the expenses are deducted. These may be finely broken down into major groups such as selling expenses and general and administrative expenses (overhead), although most income statements show single values only and may explain the details through a footnote or supplementary schedule. When expenses are deducted from gross profit, the result is the net operating profit.
Next, ‘other’ income and expenses are added or deducted. These include items such as currency exchange, one-time losses or adjustments, proceeds from the sale of capital assets, interest income or expenses, income from trading in derivatives, and all other nonoperating profit or loss. When the other income and expense net is added to or deducted from net operating profit, the result is called pretax profit. If other income exceeds other expense, the change will increase the net profit. If other expenses are greater, the change will decrease the net profit.
The final change is the liability for income taxes. This is deducted from the pretax profit to arrive at the final number, the net profit for the period.
Financial statements all use the same basic format. This makes it easier to compare results between companies and between years.
Copyright 2011 by Michael C. Thomsett. All rights reserved. John Wiley & Sons, Inc."
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