Income Statement

Income statement, also referred to as profit and loss statement (P&L) is a company's financial statement that summarizes the revenues, costs and expenses incurred during a specific period of time - usually a fiscal quarter or year. It displays the revenues recognized for a specific period, and the cost and expenses charged against these revenues, including write-offs (e.g., depreciation) and taxes, thus indicating how the revenue (money received from the sale of products and services) is transformed into the net income (the result after all revenues and expenses have been accounted for).

In contrast to the Balance Sheet, which is a snapshot of the financial condition of a company at a certain point in time, the Profit and Loss statement shows the results of financial operations over a period of time which could be a month, a quarter or a year.

A firm must create a profit in order to survive and remain solvent. The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported. Careful analysis of the components of a P&L helps in determining the cash flow available to repay existing debt, finance additional debt or to reinvest in the company. It is a valuable tool to monitor operations. A regularly prepared P & L statement - either quarterly or monthly will give owners timely information regarding revenues and expenses and tell them whether adjustments might be necessary to recoup losses or decrease expenses. These records provide information that shows the ability of a company to generate profit by increasing revenue and reducing costs. It is an important indicator of management's ability to utilize company's resources efficiently.

Preparation of P & L statement is also required by the IRS. It is the record of a business' operation that is used to assess taxes on profits earned. It is the only financial statement required by the IRS.

The income statement can be prepared in one of two methods. The Single Step income statement takes a simpler approach, totaling revenues and subtracting expenses to find the bottom line. The more complex Multi-Step income statement (as the name implies) takes several steps to find the bottom line, starting with the gross profit. It then calculates operating expenses and, when deducted from the gross profit, yields income from operations. Adding to income from operations is the difference of other revenues and other expenses. When combined with income from operations, this yields income before taxes. The final step is to deduct taxes, which finally produces the net income for the period measured.

The following is a typical P&L statement.

Sales

- Cost of Goods Sold (Beginning Inventory + Purchases of Inventory - Ending Inventory)

= Gross Profit

- Selling & Gen. Admin.

= Operating Profit

- Officer Salaries

- Interest

- Depreciation

- Rent

+/- Other Income/Expenses

= Income Before Tax

- Taxes

= Profit After Tax or Net profit

Income statements help investors and creditors determine the past financial performance of the enterprise, predict future performance, and assess the capability of generating future cash flows through report of the income and expenses. However, it has its own limitations. For e.g. items like brand recognition and loyalty that might be relevant but cannot be reliably measured are not reported. Similarly some numbers depend on accounting methods used (e.g. using FIFO or LIFO method to measure inventory level) while some others depend on judgments and estimates (e.g. depreciation expense depends on estimated useful life and salvage value). Thus it cannot be said to be 100% objective and free from bias.