Cashflow forecasts, revenue reports, balance sheets. The number of financial documents involved in running a company can make even the most dedicated director’s head spin. But these documents don’t need to be confined to your accountant’s desk.
By learning the fundamentals of the ‘big three’ statements, of which the income statement is one, you can gain a valuable view of your company’s health. In this article, we’ll explain the ins and outs of what an income statement includes and how you can use it to track profitability over time.
What is an income statement?
An income statement is one of the main financial documents you must produce by law at least once per year. It’s a historical record of your business’s trading over a specific period (usually one year). The income statement shows the profit and loss of the company, which is the difference between the total income and the total costs – this is why it’s also called a profit and loss statement (P&L).
What is an income statement used for?
The income statement (also known as the profit & loss or income & expenditure statement) allows the directors to meet their legal obligation to report on the financial activity of the company, but there are other benefits to this financial document beyond compliance.
The income statement shows the owners and shareholders how the business performed and whether it made a profit. By looking at net profit (gross profit minus expenses), you can figure out whether your profit is sustainable. Alongside your cash flow statement, your income statement can also help banks and other finance providers see if your business can make enough profit to stay in operation.
What‘s the difference between an income statement, a balance sheet and cash flow statement?
The ‘big three’ financial reports used to summarise your business’s health are your income statement, balance sheet and cash flow statement.
Income statement - Records revenue and expenses, usually on a monthly basis. As the name implies, it details the company’s income and subtracts various costs to show gross profit, operating profit and profit before tax.
Balance sheet - While the income statement shows what happened over a set period, the balance sheet is a snapshot of where the business stands at a particular point in time, such as the end of a quarter or year. It shows what the company owes and owns in terms of assets (e.g. property, furniture, equipment, stock for sale, cash and money owed to you) and liabilities (e.g. bank overdraft and loans). Find out more about how balance sheets work.
Cash flow statement - This shows where the business’s money comes from and how it’s used. Unlike an income statement and balance sheet, it doesn’t include future income or outgoings. It just focuses on cash flow during a specific period.
In combination, these three documents provide an insight into your business’s past, present and future financial situation. Financial models use the trends in these reports to forecast the company’s future performance.
What an income statement looks like
What each element of an income statement means
Revenue: The revenue or total value of sales made in the relevant period.
Cost of sales: Direct costs of making the above revenue, e.g. cost of raw materials and direct labour costs of production.
Gross profit: The difference between cost of sales and revenue. Used to calculate the gross profit margin (%).
Distribution & admin expenses: Operating costs not directly related to producing goods/services, e.g. marketing, transport, admin costs.
Operating profit: The profit from the normal operating activities of the business (usually income from sales, minus the cost of goods, services and salaries).
Finance expenses: Interest paid on borrowed money, less interest income received on cash balances (helps shareholders see how much profit is used by the company’s funding structure).
Profit before tax: Operating profit minus finance expenses.
Tax: An estimate of the amount of corporation tax that will be due on the profit before tax.
Profit attributable to shareholders: The amount of profit remaining after tax. Shareholders decide how much of this is paid out to them versus kept in the business.
How can analysing income statements help the business?
By taking a close look at an income statement, you can:
- Determine your best months. What contributed to these particularly successful times? For instance, perhaps you invested more in marketing, which increased sales.
- Assess expenses. What are your largest expenses and how can you reduce them?
- Make comparisons. By comparing multiple income statements, you can make year-to-year comparisons and look for drastic changes. The profit attributable to shareholders or ‘bottom line’ of your income statement is one of the clearest indicators of your business’s health.
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