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Investment - Income Statement
The income statement identifies the profit or loss created by a company for a certain time period, such as a year. Generating profit over time is vital for a firm to continue in business. In practice, the income statement may be referred to as the P&L (short for profit and loss).
In its most basic form, the income statement can be expressed by the following equation:
Profit (loss) = Revenues – Expenses
Expenses are the cost of firm resources — cash, inventories, equipment, and so on — that are utilized to earn sales. Expenses can be classified into categories that reflect their role:
Operating expenses comprise the cost of sales or cost of products sold; selling, general, and administrative expenses (SGA); and depreciation expenses
Financing charges, which include interest expenses
Income taxes
Gross Profit, Operating Profit, and Net Profit
Analysts refer to three metrics of profit: gross profit, operating profit, and net profit.
Gross Profit
Gross profit, which accounts for the cost of creating or acquiring the company’s products or services, is measured as:
Gross profit = Revenues – Cost of sales
Of course, cost of sales is not the only cost borne by a corporation in its efforts to sell products or services
Operating Profit
Other operating expenses include marketing expenses, which are the costs of promoting the products or services to customers; administrative expenses, which are the costs of running the company that are not directly related to production or sales, such as executive salaries and utility costs; and depreciation expenses, which are the annual non-cash expenses allocated to long-term assets, such as equipment.
Subtracting these additional costs from gross profit generates operating profit or operating income:
Operating profit = Gross profit – Other operating expenditures
Operating profit is typically referred to as earnings before interest and taxes, or EBIT.1 Operating income is the income (profits) earned by the company before factoring finance costs (interest) and taxes.
Another measure of income widely used by analysts is earnings before interest, taxes, depreciation, and amortisation (EBITDA), which is operational profit before depreciation and amortisation expenditures are deducted:
EBITDA = EBIT (or operational income) + Depreciation + Amortisation
The depreciation and amortisation values are not cash flows, and they are decided by the choice of accounting system rather than by operating actions. EBITDA is a measure of the company’s operating performance and its management’s ability to produce revenues and control expenses that are relevant to its operations. EBITDA may be a better measure than EBIT of management’s capacity to manage the revenues and expenses within its control. But EBITDA does not appear on a company’s income statement.
Net Profit
If the corporation has borrowed money to finance its activities, it will have to pay interest. Deducting interest expense from operational income determines a company’s earnings before taxes, or profit before tax:
Earnings before taxes = EBIT (or operating profit) – Interest expense
The income taxes owing by the corporation on its earnings are then deducted to arrive at net income or net profit or profit after tax:
Net income = EBIT (or operating income) – Interest expense – Tax expense
= Earnings before taxes – Tax expense
Net income indicates the income that the company has available to retain and reinvest in the company (retained earnings) or to distribute to owners in the form of dividends (disbursements of profit).
Note in the sample income statement that the net income of USD76 million minus the dividends paid of USD43 million equals USD33 million, which is the same amount as the change in retained earnings from 20X1 to 20X2 as shown on the balance sheet from Lesson 2 ($148 million – $115 million = $33 million).
The company’s owners (shareholders) are interested to know how much income the company has created per share, which is called earnings per share (EPS). It is approximated as net income divided by the number of shares outstanding. Investors are also interested in the amount of dividends the company pays for each share outstanding, or dividend per share.
The income statement identifies the profit or loss created by a company for a certain time period, such as a year. Generating profit over time is vital for a firm to continue in business. In practice, the income statement may be referred to as the P&L (short for profit and loss).
In its most basic form, the income statement can be expressed by the following equation:
Profit (loss) = Revenues – Expenses
Expenses are the cost of firm resources — cash, inventories, equipment, and so on — that are utilized to earn sales. Expenses can be classified into categories that reflect their role:
Operating expenses comprise the cost of sales or cost of products sold; selling, general, and administrative expenses (SGA); and depreciation expenses
Financing charges, which include interest expenses
Income taxes
Gross Profit, Operating Profit, and Net Profit
Analysts refer to three metrics of profit: gross profit, operating profit, and net profit.
Gross Profit
Gross profit, which accounts for the cost of creating or acquiring the company’s products or services, is measured as:
Gross profit = Revenues – Cost of sales
Of course, cost of sales is not the only cost borne by a corporation in its efforts to sell products or services
Operating Profit
Other operating expenses include marketing expenses, which are the costs of promoting the products or services to customers; administrative expenses, which are the costs of running the company that are not directly related to production or sales, such as executive salaries and utility costs; and depreciation expenses, which are the annual non-cash expenses allocated to long-term assets, such as equipment.
Subtracting these additional costs from gross profit generates operating profit or operating income:
Operating profit = Gross profit – Other operating expenditures
Operating profit is typically referred to as earnings before interest and taxes, or EBIT.1 Operating income is the income (profits) earned by the company before factoring finance costs (interest) and taxes.
Another measure of income widely used by analysts is earnings before interest, taxes, depreciation, and amortisation (EBITDA), which is operational profit before depreciation and amortisation expenditures are deducted:
EBITDA = EBIT (or operational income) + Depreciation + Amortisation
The depreciation and amortisation values are not cash flows, and they are decided by the choice of accounting system rather than by operating actions. EBITDA is a measure of the company’s operating performance and its management’s ability to produce revenues and control expenses that are relevant to its operations. EBITDA may be a better measure than EBIT of management’s capacity to manage the revenues and expenses within its control. But EBITDA does not appear on a company’s income statement.
Net Profit
If the corporation has borrowed money to finance its activities, it will have to pay interest. Deducting interest expense from operational income determines a company’s earnings before taxes, or profit before tax:
Earnings before taxes = EBIT (or operating profit) – Interest expense
The income taxes owing by the corporation on its earnings are then deducted to arrive at net income or net profit or profit after tax:
Net income = EBIT (or operating income) – Interest expense – Tax expense
= Earnings before taxes – Tax expense
Net income indicates the income that the company has available to retain and reinvest in the company (retained earnings) or to distribute to owners in the form of dividends (disbursements of profit).
Note in the sample income statement that the net income of USD76 million minus the dividends paid of USD43 million equals USD33 million, which is the same amount as the change in retained earnings from 20X1 to 20X2 as shown on the balance sheet from Lesson 2 ($148 million – $115 million = $33 million).
The company’s owners (shareholders) are interested to know how much income the company has created per share, which is called earnings per share (EPS). It is approximated as net income divided by the number of shares outstanding. Investors are also interested in the amount of dividends the company pays for each share outstanding, or dividend per share.
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