Profit and Loss Account: How to Read and Use It (2023)

What is an income statement?

An income statement is one of the three most importantfinancial statementsUsed for company reportingfinancial performanceover a specific billing period. The other two key statements are thosebalance sheetand thecash flow statement.

The income statement focuses on a company's revenue, expenses, profits, and losses during a specific period of time. Also known as theor the Statement of Income and Expenditure, an income statement provides valuable insight into a company's operations, the efficiency of its management, underperforming sectors, and its performance relative to industry peers.

Understanding the income statement

The income statement is an integral part of the company performance reports that are required to be filed in the United States.Securities and Exchange Commission(SEC). While a balance sheet represents a snapshot of a company's financials as of a specific date, the income statement shows revenue over a specific period of time, usually a quarter or a year, and its heading indicates the duration, which can be as follows"For the (fiscal) year/quarter ended June 30, 2021."

The income statement focuses on four main items: income, expenses, profits and losses. No distinction is made between cash and non-cash receipts (cash sales vs. credit sales) or cash and non-cash payments/payments (cash purchases vs. credit purchases). That starts with the detailssaleand then works down to calculatenet incomeand finallyEarnings per share (EPS). Essentially, it gives an overview of how thenet salesrealized by the company is transformed intonet profit service(profit or loss).

revenue and profits

The following items are included in the income statement, although their format may vary depending on local regulatory requirements, the diversified scope of the business and related operational activities:

operating income

Revenues realized through primary activities are often referred to asoperating income. For a company that manufactures a product, or for a wholesaler, distributor, or retailer involved in the sale of that product, revenue from primary activities refers to revenue generated from the sale of the product. Similarly, revenue from primary activities for a business (or its franchisees) that provides services refers to the revenue or fees earned in exchange for providing those services.

Non-operating Income

Revenue generated from secondary, non-core activities is often referred to as non-operating recurring revenue. This income comes from income outside of the buying and selling of goods and services and may include income from interest income from business capital parked in the bank, rental income from commercial real estate, income from strategic partnerships such as income from royalties, or income from an advertising display that placed on commercial property.

profits

Also known as other income, profits indicate the net money made from other activities such as the sale of long-term assets. This includes the net income generated from one-off non-business activities, such as B. A company selling its old van, unused land or a subsidiary.

Income should not be confused with income. Payments are generally recognized in the period in which sales are made or services are rendered. Revenue is the money received and is posted when the money is received.

A customer can purchase goods/services from a company on September 28th, resulting in the revenue recorded in September. The customer can be given a 30-day payment window due to their excellent credit and reputation, allowing them to make the payment by October 28th, when the receipts will be posted.

expenses and losses

The cost of a business to continue operations and make a profit is known as expenses. Some of themCostcan be written off on a tax return if they meet Internal Revenue Service (IRS) guidelines.

Expenses for primary activities

These are all expenses incurred to generate average operating income related to the main activity of the company. This includes thecost of goods sold(COGS);Sales General and administration(SG&A) expenses;depreciationorAmortisation; andResearch and Development(R&D) expenditure. Typical items that make up the list are employee wages, sales commissions and expenses for utilities such as electricity and transportation.

sideline costs

These are all expenses related to non-core activities such asInterestpaid with borrowed money.

losses as expenses

These are all expenses used for a loss-making sale of long-term assets, one-off or other unusual expenses, or litigation expenses.

While the primary income and expenses provide insights into the performance of the company's core business, the secondary income and fees consider the company's commitment and expertise in managing ad hoc, non-core activities. Clearly high-yield earnings from cash in the bank compared to earnings from the sale of manufactured goods indicate that the company may not be making full use of available cash by expanding production capacity, or it may be facing challenges in increasing market share in the Contest.

Recurring rental income generated by the placement of billboards at the company's factory along a highway demonstrates that management is using available resources and assets for additional profitability.

Structure of the income statement

The net income is calculated as follows:

Net Income = (Revenues + Profits) - (Expenses + Losses)

To understand the above formula with some real numbers, let's assume that a fictional sporting goods company that also offers training reports its income statement for a recent hypothetical quarter.

It received $25,800 from sales of sporting goods and $5,000 from training services. Various amounts were spent on the indicated activities totaling $10,650. It realized a net gain of $2,000 from the sale of an old pickup truck and suffered losses of $800 settling a dispute raised by a consumer. Net income is $21,350 for each quarter. The example above is the simplest form of income statement that any standard business can create. It's called thesingle-stage income statementas it is based on a simple calculation that sums income and profits and subtracts expenses and losses.

However, real companies often operate on a global scale, have diversified business segments that offer a mix of products and services, and often engageThe fusion,acquisitions, and strategic partnerships. Such a wide range of operations, diversified expenses, various business activities and the need to report in a standard format in accordance with legal regulations result in multiple and complex accounting entries in the income statement.

Listed companies follow themulti-level income statement, which separates the operating income, operating expenses and profits from the non-operating income, non-operating expenses and losses and provides many more details through the income statement created in this way.

Essentially, the various profitability metrics are reported in a multi-level income statement at four different levels in a company's operations: gross, operating, before tax, and after tax. As we will shortly see in the example below, this separation helps to see how income and profitability move/change from one level to another. For example, high gross profit but lower operating income indicates higher expenses, while higher pre-tax income and lower after-tax income indicate a loss of revenue from taxes and other one-time, unusual expenses.

Let's look at an example based on the 2021 annual results of two large, publicly traded, multinational companies in different sectors: technology (Microsoft) and retail (Walmart).

Read income statements

The emphasis in this standard format is on calculating the profit/income on each sub-item of income and operating expenses and accounting for mandatory taxes, interest and other one-off, non-recurring events to determine the net income applicable to common stock. Although calculations involve simple additions and subtractions, the order in which the various items appear in the statement and their relationships are often repeated and complicated. Let's take a deep dive into these numbers to understand them better.

Revenue section

The first section, titled Revenue, states that Microsoft'sGross (Annual) Profit, or Gross Margin, for the year ended June 30, 2021 was $115.86 billion. It was achieved by subtracting cost of sales ($52.23 billion) from total revenue ($168.09 billion) generated by the tech giant this fiscal year. Just over 30% of Microsoft's total revenue went into revenue-generation costs, while Walmart posted a similar number in fiscal 2021 was about 75% (US$429bn/US$572.75bn).It indicates that Walmart has incurred much higher costs than Microsoft to generate equivalent sales.

operating expenses

The next section, titled "Operating Expenses," again considers Microsoft's cost of sales ($52.23 billion) and total revenue ($168.09 billion) for the fiscal year to arrive at the reported numbers. Since Microsoft spent $20.72 billion on R&D and $25.23 billion on SG&A, total operating expenses are calculated by adding all these numbers together ($52.23 billion + $20.72 billion + $25.23 billion = $98.18 billion).

Reducing total operating expenses from total revenues results in operating revenues (or losses) of $69.92 billion ($168.09 billion - $98.18 billion).This figure represents theEarnings before interest and taxes(EBIT) for the core business and is later used again to derive the net profit for the year.

Comparing line items shows that Walmart spent nothing on R&D and had higher SG&A and total cost of ownership than Microsoft.

Income from continuing operations

The next section, titled "Income from continuing operations," adds other net income or expenses (such as one-time income), interest-related expenses, and applicable taxes to arrive at net income from continuing operations ($61.27 billion) for Microsoft nearly 60% higher than Walmart's ($13.67 billion).

After discounting one-time events, it is possible to determine the value of net income applicable to common stock. Microsoft had one much higher net income of $61.27 billion compared to Walmart's $13.67 billion.

Earnings per share is calculated by dividing net income by the number of weighted average shares outstanding. With 7.55 billion shares outstanding for Microsoft, 2021 earnings per share were $8.12 ($61.27 billion ÷ $7.55 billion).Because Walmart had 2.79 billion shares outstanding this fiscal year, its earnings per share came up USD 4.90 pro Share (USD 13.67 ÷ USD 2.79).

Microsoft had lower costs of generating equivalent earnings, higher net income from continuing operations, and higher net income for common stock compared to Walmart.

Use of Profit and Loss Accounts

Although the primary purpose of an income statement is to provide stakeholders with details about the company's profitability and operations, it also provides detailed insight into the company's internal activities for comparison across different companies and sectors. By understanding the income and expense components of the statement, an investor can appreciate what makes a company profitable.

Based on income statements, management can make decisions such as: B. expanding into new regions, increasing sales, expanding production capacity, increasing utilization or selling assets outright, or closing a division or product line. Competitors can also use them to gain insights into a company's success metrics and focus areas such as increasing R&D spending.

Creditors may find income statements of limited use because they are more concerned about a company's future cash flows than its past profitability. Research analysts use the income statement to compare year-to-year and quarter-to-quarter performance. For example, one can deduce whether a company's efforts to reduce the cost of sales have helped improve profits over time, or whether management has been keeping an eye on operating costs without impacting profitability.

The final result

An income statement provides valuable insight into various aspects of a business. It includes metrics on a company's operations, the efficiency of its management, the potential leaks that can eat away at profits, and whether the company compares to industry peers.