Income Statement Analysis: How to Read an Income Statement

In this article, we will discuss the presentation or preparation of income statement by function. Prepare multi-step income statement for CPT for the year ended 30th June, 2016. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future.

• Vertical analysis refers to the method of financial analysis where each line item is listed as a percentage of a base figure within the statement.
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• IFRS preparers have some flexibility in selecting their income statement format and which line items, headings and subtotals are to be presented on the face of the statement.
• On Clear Lake’s income statement in Figure 5.2, we see its top line referred to as Sales.
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Although the format of the income statement is not prescribed, certain items require presentation, if material, either on the face of the income statement or disclosed in the notes to the financial statements. Here we highlight certain items common for commercial or industrial companies and how they should be presented in the income statement. The cash flow statement provides a view of a company’s overall liquidity by showing cash transaction activities. It reports all cash inflows and outflows over the course of an accounting period with a summation of the total cash available. The information found on the financial statements of an organization is the foundation of corporate accounting. This data is reviewed by management, investors, and lenders for the purpose of assessing the company’s financial position.

Expenses in an income statement are either classified by their nature or by their function. For nonprofit organizations, the standards dictate that expenses must be presented by vendor financial services their function. These expenses are reported in the Statement of Functional Expenses and Statement of Activities, two unique Financial Statements in nonprofit organizations.

An income statement represents a period of time (as does the cash flow statement). This contrasts with the balance sheet, which represents a single moment in time. Small businesses typically start producing income statements when a bank or investor wants to review the financial performance of their business to see how profitable they are. While gross profit reflects only how profitable the firm was in making its core product, operating income reflects how profitable the firm’s daily operations were as a whole. This still does not include other miscellaneous items outside the scope of a firm’s normal business. Just as the name implies, it shows income from the core operations of the firm.

Components of a Single-Step Income Statement

These factors may include, but are not limited to, historical and industrial factors and the nature of the business. The expenses of the business can either be presented by their function or by their nature. As demonstrated above, the expenses of the business must be deducted from its revenues to reach its Gross Profit and Net Profit. When all the expenses of the business are subtracted from the revenues of the business, it is known as the Net Profit of the business. IFRS does not describe events or items of income or expense as ‘unusual’ or ‘exceptional’. However, the presentation, disclosure or characterization of an item as extraordinary is prohibited.

EBIT is helpful when analyzing the performance of the operations of a company without the costs of the tax expenses and capital structure impacting profit. Non-operating revenues are revenues that a company earns from activities that are not related to its primary business operations. Non-operating items are further classified into non-operating revenue and non-operating expenses. The Internal Revenue Service (IRS) permits businesses to deduct operating expenses if the business operates to gain profits.

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This allows businesses to better control expenses by allowing them to narrow the expense down to the activity where the expense is being incurred in. For example, the depreciation of a building used by the business can be split into different activities and apportioned to the related functions, such as administrative, marketing, production, etc. These expenses are presented by their functions, usually Program Costs and Operating Costs. A breakup of the functional expenses by their nature is then provided in the Statement of Functional Expenses of the organization. Most businesses around the world choose the option to present expenses in their Income Statements by their function. The management of a business usually take different factors when choosing between the two presentations.

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Download our free course flowchart to determine which best aligns with your goals. Because of this, horizontal analysis is important to investors and analysts. By conducting a horizontal analysis, you can tell what’s been driving an organization’s financial performance over the years and spot trends and growth patterns, line item by line item. Ultimately, horizontal analysis is used to identify trends over time—comparisons from Q1 to Q2, for example—instead of revealing how individual line items relate to others. Horizontal analysis makes financial data and reporting consistent per generally accepted accounting principles (GAAP). It improves the review of a company’s consistency over time, as well as its growth compared to competitors.

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Another use is to track income statement line items over time, to see if there are any spikes or dips in the data that indicate the presence of problems that management should address. Vertical analysis refers to the method of financial analysis where each line item is listed as a percentage of a base figure within the statement. This means line items on income statements are stated in percentages of gross sales, instead of in exact amounts of money, such as dollars.

Income Statement

If you are new to HBS Online, you will be required to set up an account before starting an application for the program of your choice. Gross Profit Gross profit is calculated by subtracting Cost of Goods Sold (or Cost of Sales) from Sales Revenue. We follow strict ethical journalism practices, which includes presenting unbiased information and citing reliable, attributed resources. All three documents must be reviewed together to get a clear picture of the financial health of the business. Income statements can be complex, but understanding the different components is crucial to interpretation.

Learn to analyze an income statement in CFI’s Financial Analysis Fundamentals Course. Depreciation and amortization are non-cash expenses that are created by accountants to spread out the cost of capital assets such as Property, Plant, and Equipment (PP&E). A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation.

Your reporting period is the specific timeframe the income statement covers. It is useful to include in either form of presentation as many aggregated line items and subtotals as necessary to most clearly convey to the reader the financial performance of the reporting entity. There is no required template in the accounting standards for how the income statement is to be presented. Further, the information contained within it can vary considerably by industry. Nonetheless, there are certain common elements found in most income statements, which are noted below. Depreciation expenses are reported like any other normal business expense on your income statement, but where you include it depends on the nature of the asset being depreciated.

Net income (or loss) reflects the net impact of all financial transactions for the firm, including those that are caused by events outside the normal course of business. The most common items deducted from operating income to arrive at net income include interest expense, gains/losses, and income tax expense. Remember, gains and losses are those that result from unusual transactions outside the normal course of business. Examples include selling a piece of old equipment or a loss on retiring debt. Though financial statements are required to follow a certain format, account names can differ slightly from one firm to another.