If you’re studying a business-related course, you will have come across the 3 financial statements. As the fundamental statements that provide a snapshot of any company’s finances, it’s important to be across all of these. This blog continues our financial statements series from last time, where we introduced the balance sheet. In this blog, we cover the income statement and go through some key links between the two statements!
The income statement (or, formally, the statement of financial performance) measures the amount of profit the business has generated over a given period. In contrast to the two-sided structure of the balance sheet, the income statement has a chronological structure that flows from top to bottom. Let’s run through some key line items in the income statement:
Revenue: The total amount of money made from business activities in the trading period. This can be thought of as the total sales the business made (i.e., total quantity of items sold multiplied by the price they were sold at).
Cost of goods sold: The cost attributable to selling goods or services. This tends to apply more to businesses which sell tangible goods, and include, for example, the cost of raw materials or packaging.
Gross profit: The difference between revenue and cost of goods sold.
(Operating) Expenses: The expenses incurred in the process of carrying out daily business activities. This can be further broken down into different categories of expenses such as maintenance costs and wages paid.
Operating profit (also known as earnings before interest and tax, or EBIT): Calculated as gross profit minus expenses, or net income plus interest and tax. This is a key measure of financial performance often used as an alternative to net income. It focuses solely on a company’s ability to generate earnings from its core operations, ignoring taxes and interest expense.
Earnings before interest, tax, depreciation, and amortisation (EBITDA): Operating profit plus depreciation and amortisation. This is another measure of financial performance. It shows earnings before the influence of extraneous deductions, and is therefore more likely than EBIT to be used in the valuation of capital-intensive firms or firms amortising large amounts of intangible assets.
Net profit after taxes (NPAT): This represents the amount of change in owners’ equity. If it is positive, this amount will be added onto the owners’ equity from last period to make up the owners’ equity for this period on the balance sheet. This is one key way in which the two statements link together.
Has that provided you with a better understanding of the income statement? It’s a very important document that presents a ‘flow’ rather than ‘static’ view of the company’s finances in companies’ key reports. It paints a picture of a company’s overall performance over a period of time, and deconstructs its main sources of income as well as costs.
Disclaimer: The intent of this blog is to provide careers advice, not financial advice. It does not take into account individual circumstances. For financial advice, please see a financial adviser.
