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Income Statement May 26, 2007

Posted by Muhammad Habib in Oracle Financials.
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An Income Statement, also called a Profit and Loss Statement (P&L), is a financial statement for companies that indicates how net revenue (money received from the sale of products and services before expenses are taken out, also known as the “top line”) is transformed into net income (the result after all revenues and expenses have been accounted for, also known as the “bottom line”). The purpose of the income statement is to show managers and investors whether the company made or lost money during the period being reported.

In reference to charitable organizations, an income statement is called a Statement of Activities and Changes in Net Assets.

Usefulness and limitations of income statement

Income statements should help investors and creditors determine the past performance of the enterprise; predict future performance; and assess the risk of achieving future cash flows.

However, information in an income statement has several limitations:

  • items that might be relevant but cannot be reliably measured are not reported (e.g. brand recognition and loyalty)
  • some numbers depend on accounting methods used (e.g. using FIFO or LIFO accounting to measure inventory level)
  • some numbers depend on judgments and estimates (e.g. depreciation expense depends on estimated useful life and salvage value).

Single-step income statement

In the single-step statement, just two groups exist: revenues and expenses. Expenses are deducted from revenues to get net income (single step). Its main advantage is simplicity, but more and more companies choose multiple-step statements. The basic format is shown below.

Revenue
  Net sales ____________________$3,400,000
  Rent revenue _________________    40,000
  Interest revenue _____________    12,000
    Total revenue ______________ 3,452,000
 
Expenses (usually sorted by amount)
  Cost of goods sold ___________ 2,000,000
  Selling expenses _____________   450,000
  Administrative expenses ______   350,000
  Interest expense _____________    45,000
    Total expenses _____________ 2,845,000
 
Income before taxes ____________   607,000
Income taxes ___________________   182,100
Net income _____________________   424,900
 
Earnings per share _____________     $4.20

Based on 100,000 shares.

The basic sections are shown below.

PROFIT AND LOSS SEPT 2006

    Net Revenue                           13,812
-   Cost of Sales (or Cost of Goods Sold) 10,825
=   Gross Margin or Profit                 2,987
-   Selling Expenses                         530
-   General and Administrative Expenses    1,335
=   Operating Profit                       1,122
-   Interest Expense                           0
-   Other Expenses or Losses                   0
=   Earnings Before Taxes                  1,122
-   Taxes                                    392
=   Earnings Before Irregular Items          720
 
-/+ Changes in Accounting Principle        
=   Net Income                          1,122
    Earnings Per Share

 

Items on income statement

 

Operating section

  • Net Revenue – Inflows or other enhancements of assets of an entity or settlements of its liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations. Usually presented as sales minus sales discounts, returns, and allowances.
  • Expenses – Outflows or other using-up of assets or incurrence of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations.
    • Cost of goods sold – represents the amount a product costs to produce
    • General and administrative expenses (G & A) – represent expenses to manage the business (officer salaries, legal and professional fees, utilities, insurance, depreciation of office building and equipment, stationery, supplies)
    • Selling expenses – represent expenses needed to sell products (e.g., sales salaries and commissions, advertising, freight, shipping, depreciation of sales equipment)
    • R & D expenses – represent expenses included in research and development
    • Depreciation – represents costs associated with depreciated assets

Non-operating section

  • Other revenues or gains – revenues and gains from other than primary business activities (e.g. rent, patents). It also includes unusual gains and losses that are either unusual or infrequent, but not both (e.g. sale of securities or fixed assets).
  • Other expenses or losses – expenses or losses not related to primary business operations.

Irregular items

They are reported separately because this way users can better predict future cash flows – irregular items most likely won’t happen next year. These are reported net of taxes.

  • Discontinued operations is the most common type of irregular items. Shifting business location, stopping production temporarily, or changes due to technological improvement do not qualify as discontinued operations.
  • Extraordinary items are both unusual (abnormal) and infrequent, for example, unexpected nature disaster, expropriation, prohibitions under new regulations. Note: natural disaster might not qualify depending on location (e.g. frost damage would not qualify in Canada but would in the tropics).
  • Changes in accounting principle is, for example, changing method of computing depreciation from straight-line to sum-of-the-years’-digits. However, changes in estimates (e.g. estimated useful life of a fixed asset) do not qualify.

Earnings per share

Because of its importance, earnings per share (EPS) are required to be disclosed on the face of the income statement. A company which reports any of the irregular items must also report EPS for these items either in the statement or in the notes.

Earnings\ per\ share = \frac{net\ income - preferred\ stock\ dividends}{weighted\ average\ of\ common\ stock\ shares\ outstanding}

There are two forms of EPS reported:

  • Basic: in this case “weighted average of shares outstanding” includes only actual stocks outstanding.
  • Diluted: in this case “weighted average of shares outstanding” is calculated as if all stock options, convertible bonds, and other securities that could be transformed into shares are transformed. This way number of shares increases and EPS decreases. Diluted EPS is considered to be a more accurate way to measure EPS.

Alternative setup of multiple-step income statement

Setups of income statements come in many shapes and forms. Below is an alternative definition which carries a direct relationship to terminology commonly used in financial analysis. On the right hand side of the table several alternative suggestions for terminology are listed – economics and accounting is by no means a discipline with a single standard definition of terms used. Hence, part of the skill in understanding income statements and balance sheets is to see through the words.

Income statement item      Acronym spelled out       Alternative terminology

Revenues                                             Sales, Income, Turnover
-CoGS                      Cost of Goods Sold        Cost of sales
--------------------------------------------------------------------------------------------------
EBITDA                     Earnings before I+T+D+A   Gross margin, Gross profit, Operating margin
- Depreciation
- Amortization
--------------------------------------------------------------------------------------------------
EBIT                       Earnings before I+T       Financial items, Financial income,
-                                                      Financial expense
--------------------------------------------------------------------------------------------------
EBT                        Earnings before Taxes     Pretax net income
- Taxes
--------------------------------------------------------------------------------------------------
E                          Earnings                  Net income

 

Simple example: Colgate-Palmolive income statement

                           COLGATE-PALMOLIVE COMPANY   
                       CONSOLIDATED STATEMENTS OF INCOME
                (Dollars in Millions Except Per Share Amounts)
         
 Revenues                             $10,584.2    $  9,903.4     $  9,294.3
 Cost of sales                          4,747.2       4,456.1        4,224.2
------------------------------------------------------------------------------
    Gross profit                        5,837.0       5,447.3        5,070.1
 Selling, general and administrative
  expenses                              3,624.6       3,296.3        3,034.0
 Other (income) expense, net               90.3         (15.0)          23.0      
------------------------------------------------------------------------------
    Operating profit                    2,122.1       2,166.0        2,013.1
 Interest expense, net                    119.7         124.1          142.8
------------------------------------------------------------------------------
    Income before income taxes          2,002.4       2,041.9        1,870.3
 Provision for income taxes               680.3         620.6          582.0
------------------------------------------------------------------------------
    Net income                        $ 1,327.1    $  1,421.3     $  1,288.3
------------------------------------------------------------------------------
 Earnings per common share, basic     $    2.45    $     2.60     $     2.33
 Earnings per common share, diluted   $    2.33    $     2.46     $     2.19

 

Complex example: Viacom, Inc. income statement

                                VIACOM INC. AND SUBSIDIARIES
                            CONSOLIDATED STATEMENTS OF OPERATIONS
                           (In millions, except per share amounts)      
----------------------------------------------------------------------------------------------
  Year Ended December 31,                                   2004         2003         2002
----------------------------------------------------------------------------------------------
 Revenues                                               $ 22,525.9   $ 20,827.6   $19,186.8   
 Expenses:                     
    Operating                                             12,545.8     11,879.8    10,735.5   
    Selling, general and administrative                    4,142.1      3,732.3     3,498.6   
    Depreciation and amortization                            809.9        741.9       711.8   
    Impairment charge (Note 3)                            17,997.1                           
----------------------------------------------------------------------------------------------
      Total expenses                                      35,494.9     16,354.0    14,945.9   
----------------------------------------------------------------------------------------------
 Operating income (loss)                                 (12,969.0)     4,473.6      4,240.9
 Interest expense                                           (718.9)      (742.9)      (799.1)
 Interest income                                              25.3         11.7        12.0   
 Other items, net                                              7.6         (3.0)       (32.9)
----------------------------------------------------------------------------------------------
 Earnings (loss) from continuing operations before
  income taxes, equity in earnings (loss) of affiliated
  companies and minority interest                        (13,655.0)     3,739.4     3,420.9   
 Provision for income taxes                               (1,378.6)    (1,497.0)    (1,338.3)
 Equity in earnings (loss) of affiliated companies,
  net of tax                                                 (20.8)          .1        (37.3)
 Minority interest, net of tax                                (5.1)        (4.7)        (3.3)
----------------------------------------------------------------------------------------------
 Net earnings (loss) from continuing operations          (15,059.5)     2,237.8      2,042.0  
----------------------------------------------------------------------------------------------
 Discontinued operations (Note 2):                     
    Earnings (loss) from discontinued operations          (1,182.7)      (718.8)      255.3   
    Income taxes, net of minority interest                    92.4        (83.6)       (90.7)
----------------------------------------------------------------------------------------------
    Net earnings (loss) from discontinued operations      (1,090.3)      (802.4)       164.6  
----------------------------------------------------------------------------------------------
 Net earnings (loss) before cumulative effect of
  accounting change                                      (16,149.8)     1,435.4     2,206.6   
 Cumulative effect of accounting change, net of minority
  interest and tax (Note 1)                               (1,312.4)       (18.5)    (1,480.9)
----------------------------------------------------------------------------------------------
 Net earnings (loss)                                   $ (17,462.2)   $ 1,416.9   $   725.7   
----------------------------------------------------------------------------------------------
  
 Basic earnings (loss) per common share:
    Net earnings (loss) from continuing operations         $ (8.78)      $ 1.28       $1.16   
    Net earnings (loss) from discontinued operations       $  (.64)      $ (.46)      $  .09   
    Net earnings (loss) before cumulative effect of
     accounting change                                     $ (9.42)      $  .82       $ 1.26   
    Cumulative effect of accounting change                 $  (.77)      $ (.01)      $ (.84)
    Net earnings (loss)                                    $(10.19)      $  .81       $  .41   
 Diluted earnings (loss) per common share:                     
    Net earnings (loss) from continuing operations         $ (8.78)      $ 1.27       $ 1.15   
    Net earnings (loss) from discontinued operations       $  (.64)      $ (.46)      $  .09   
    Net earnings (loss) before cumulative effect of
     accounting change                                     $ (9.42)      $  .82       $ 1.24   
    Cumulative effect of accounting change                 $  (.77)      $ (.01)      $ (.83)
    Net earnings (loss)                                    $(10.19)      $  .80       $  .41   
 
 Weighted average number of common shares outstanding:                     
    Basic                                                   1,714.4     1,744.0      1,752.8   
    Diluted                                                 1,714.4     1,760.7      1,774.8   
 
 Dividends per common share                                $   -         $  .25       $  .12

 

Top line

The term “top line” refers to the total revenues or sales mentioned in the income statement. This refers to the fact that the total revenues collected by a company appears at the top of the income statement.

 

Bottom line

The “bottom line” is the net income that is calculated after subtracting the expenses from revenue. Since this forms the last line of the income statement, it is generally referred to as the bottom line.

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