Imagine you have a company. Naturally, you want to find out how your company is doing financially. So what tools do you use to measure performance? How do you know whether your company is achieving success? How do you record your profits and expenses? Keep reading and let's find out.

This is where an income statement enters the picture. The income statement reveals information about a company's profitability and financial situation during a specific time period. We'll look at the meaning of an income statement and show you a few examples as well.

Income statement definition

The income statement is one of the most important financial statements a company will use.

It's essential to understand that the income statement gives the overall financial picture of a company during a period of time as opposed to the balance sheet, which provides an overview of the business' finances on a specific date.

An income statement provides helpful insights into the financial well-being of a company. It allows business owners to come up with better strategies, as well as to evaluate their past decisions. An income statement is also crucial for investors who are looking to put money into a business. The reason for this is that it shows a company's potential. For instance, if a company has experienced a loss instead of a profit during a given period, then investors might reconsider whether to invest in it or not.

Features of an income statement

Every company is required to disclose its income statement. The income statement provides information on the revenue the business has incurred during a period of time, usually a year. The revenue includes all the income the business has made from sales.

Secondly, the income statement serves to provide information about costs the business incurs in order to generate sales. Finally, the income statement is helpful in disclosing information about the profits realized by a firm during a financial year.

The main features of an income statement are:

Income Statements: Revenue

Revenue refers to the income the business makes by selling goods or services. The income statement shows the revenue made over a certain period. Revenue includes the total income made throughout that period.

Income Statements: Cost of sales

Cost of sales includes all costs that a company incurs in the process of producing goods and services. These costs include the salaries that a business has to pay to its workers, including the cost of raw materials, and the cost of building and maintenance. Essentially, an income statement shows all the costs the business faces during the production process.

Income Statements: Gross profit

Gross profit is the difference between revenue and cost of sales.

The formula for gross profit is:

Gross Profit = Revenue - Cost of Sales

Basically, whatever money is left after production costs is known as gross profit.

Income Statements: Overheads

Overheads are considered fixed costs, as they do not change in the short term. Regardless of the volume of production, these costs will remain steady. Such costs include the building where manufacturing occurs, interest paid on loans, insurance costs, etc.

Income Statements: Operating revenue

Operating revenue is the difference between a company's gross revenue and its overhead.

The formula for operating revenue is:

Operating Revenue = Gross Profit – Operating Revenue

Income Statements: Net profit

Net profit is one of the most important measures of how well a business is doing. It is the final feature of an income statement, and it basically shows all the money that's left for the business to take home. That is to say, there are no other expenses that need paying. Net profit can be found by taking the difference between operating profit and taxes/interest payments.

Figure 1 below shows the components of an income statement.

Income statement Example

Table 1 - Anna Ltd. Income Statement

Importance of income statement

Although the primary purpose of an income statement is to communicate the details of a company's profitability and business activities to its stakeholders, it provides internal management with valuable insights on where the business is and where it is headed. They can use the income statement to compare the company's performance across different industries and enterprises.

The income statement assists company owners in determining whether they can make a profit by growing revenues, lowering expenditures, or combining both. It also demonstrates the efficacy of the company strategy established at the start of a financial quarter. Company owners may also use this statement to determine whether or not their plans have been successful.

The income statement is often crucial when managers decide whether they want to expand into new areas or increase their manufacturing capabilities. This information is helpful not only to the management of a business but also to its competitors. Competitors can use these income statements to reflect upon their performance and try and research new strategies to implement.

Another essential aspect of an income statement is that it provides insights into how well a company is doing to the general public. This can also measure the success of a certain industry, but it is also essential when the company is publicly traded, and new investors want to invest in it. It is wise to check the income statement before investing in any company.