How to read income statements?

What is a income statements?

The income statement also known as 'profit & loss statement' is the crucial statement in any business. Income statement shows the most critical perspective of a company - it's profitability. 

It gives an overview how much was sold(Sales), how much cost the product to make(Costs) and how much money was left after these cost were paid(Net profit). So, the equation is,

(Total revenue generated from sales of goods & services - Costs incurred for the generation of goods & services and expenses incurred relating to the provision of goods & services) = Profit for the company

          

Read and understand the income statements of a company

Let's understand the each aspect of the statement of profit & loss statement of a company with an example.

                   

Following is the extract of statement of income account for a company.

(a)Revenue from operations

Focus on the word 'revenue', the starts with the 'revenue' from operations. Revenue is different from profit. Revenue are recorded that a moment a company ships products to customers. Revenues are also called as 'sales'.

         

Suppose, ABC company has sold 10,00,000 pens and each pen cost of Rs 5

So, the company has earned of Rs 50,00,000

So, we can say gross amount received for any transaction relating to the company's core business activity is called revenue from operations. 

(b)Other income

Other income consists of revenue that is not relating to the core business of the company. Such as company received dividend from stock market investments or profit on the sale of assets etc. These are non operating revenue of the company.

The total of the above two forms the total revenue earned by the company(a+b).

(c)Expenses

Expenses are everything a company has to pay for produce products, like production, salaries and wages, administrative expenses etc. Let discuss in detail various types of expenditures incurred by the company - 

(1)Cost of material consumed

It is the cost of raw materials used for the generation of revenue during the period. 

It is arrived by the formula - 

(Opening stock of raw materials + purchase of raw materials - closing stock of raw materials)

(2)Purchase of stock in trade

It refers to the amount of finished goods purchased during the year by the company to conduct its business.

(3)Change in the inventory of finished goods, work in progress and stock in trade

Account of the company are prepared on the basis of matching principles that is cost associated with the making of products are to be recorded at the same time of recording the revenue. 

So, production costs should be mentioned for only those goods which are actually sold during this year. Cost incurred for manufacturing closing stock should be carried to the year it is sold.

(4)Employee benefits expenses

Any expenses incurred by the company for its employees fall under this category. This includes contribution of provident funds, remuneration paid to directors etc.

(5)Finance costs

If a company borrow money to meet the fund requirement. Finance cost is the expense incurred by the company for funding its business. like - interest paid on loans.

(6)Excise duty

Excise duty was a tax applicable on the manufacturing of goods. Now, it is subsumed under GST which come into effect from 1st July 2017.

(7)Depreciation, amortization and impairment

Whenever a company buys any fixed assets its benefit is expected to be enjoyed for more than one year. So, it is capitalized in the books. Capitalized means it is not treated as expenses and charged in p/L accounts but it looked in the balance sheet as assets, and year by year, the value of assets is reduced and a little part is booked as an expenses in the name of depreciation of an assets.

     

Suppose, a company has purchased a machine for Rs 100,000 and expected life of the assets ten years and every year only Rs 1000 is charged in P/L account as depreciation. 

       

 Similarly if the company purchases any intangible assets(trademark, copyright, patent and goodwill etc) it is amortized every year.

(8)Other expenses

All the other expendable incurred by the company relating to its business shall be covered by other expenses. It includes power & fuel, rent, traveling expenses, repairs to building etc.

(d)Profit before tax

It refers to the net operating income after deducting operating expenses but before deducting interest & taxes.

       

So, PBT = Total revenue - Total expenses

(e)Net profit

Net profit sometimes called profits or earnings, show how much money a company has left after it has paid its costs, expenses and taxes. It is important to note, profit is not the same as cash.