Income Statement Basics

Basics of Income Statement

Income Statement provides a basic summary of the company’s revenues and expenses within a specified period.

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For eg:
Source: Income Statement Basics (wallstreetmojo.com)

Income statement basic equation can be presented as

Income statement equation

Basic Example of Income Statement 

Let us try to understand the basics of income statements line items with the help of an example.

The income statement equation revenue- expenses= net income for company A is presented in the table below.

The revenue for the company is 50,000. After deducting all the expenses for the company, which includes the cost of goods, SG&A, depreciation expense, interest expense, and provision for income taxes, the net income comes up to be 500.

Income Statement Example 1

Basic Components of Income Statement

We have touched base on the basic components of the income statement in the previous sections. Let us now discuss each item in detail, which makes up the income statement of a company.

The basic components of the income statement are revenue, cost of goods sold, gross profitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services.read more, selling general and administrative expenses, earnings before interest tax and depreciation, depreciation expenses, operating profit, interest expenses, taxes, and net profit.

Income Statement Components

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Source: Income Statement Basics (wallstreetmojo.com)

#1 – Revenue

It is the first line item of the income statement, and revenue is calculated by the volume for the product times the selling price. If a company has said five segments that sum up to make the total revenue, then the total of revenues for individual segments make up the total revenue. Revenue is also known as sales or turnover and used interchangeably in different countries. Sales is a very crucial figure to look at a company, for a company to expand its important for it to increase its sales over time and in a way, capture market share.

We note that Google (Alphabet) makes revenue primarily from three activities – advertising revenues from Google Properties, advertising revenues from Network Members Properties and Other revenues (includes play store, hardware, cloud services, licensing, etc.)

Google Income Statement - Geographic Segment

source: Alphabet (Google) SEC Filings

#2 – Cost of Goods Sold

The cost of goods sold is the cost of the raw materials required to manufacture products. These raw materials are sourced from different suppliers, and this cost consists of the bulk of costs required for a company to run a business and expand the business.

Cost of Goods Sold in Google primarily consists of traffic acquisition costs paid to Google Network Members for ads displayed.

Google - Income Statement - COGS

source: Alphabet (Google) SEC Filings

#3 – Gross Profit

It is the difference between the revenue of a company and the cost of goods sold for the company.

Gross Profit = Revenues – Cost of RevenuesCost Of RevenuesThe cost of revenue is the total expense incurred from manufacturing to delivering a product or service to the customer. It reflects all direct costs associated with the product or service delivered and is reflected in a company's income statements.read more

Google - Gross Profit

source: Alphabet (Google) SEC Filings

  • Gross Profit (2016) = 90,272 – 35,138 = 55,134 million
  • Gross Profit (2015) = 74,989 – 28,164 = 46,825 million

#4 – Selling General and Administration Expenses

This line item consists of all the costs required to manufacture the products and also selling those products. These costs include the cost of factory expenses to marketing expenses. These costs also include personnel costs which are paid to all the employees are it factory works or administrative staff and others who get the salary from the company.

Google Income Statement - SG&A

source: Alphabet (Google) SEC Filings

  • SG&A Expense (2016) = 10485 + 6985 = 17,470 million
  • SG&A Expense (2015) = 9047 + 6136 = 15,183 million

#5 – Depreciation Expense

Depreciation is the provision for a company to enable to buy back an asset when it is time for that asset to be scrapped. In the basic income statement, it is the expense for the period. Depreciation is a non-cash expenseNon-cash ExpenseNon-cash expenses are those expenses recorded in the firm's income statement for the period under consideration; such costs are not paid or dealt with in cash by the firm. It involves expenses such as depreciation.read more for the company.

Google - income Statement - D&A

source: Alphabet (Google) SEC Filings

  • Google’s Depreciation and Amortization Expense in 2016 was $3,523 and $1,456 million, respectively.
  • Google’s Depreciation and Amortization Expense in 2015 was $4,132 and $931 million, respectively.

#6 – Operating Profit

It is arrived at by deducting the selling general and administration expensesSelling General And Administration ExpensesSelling, general and administrative (SG&A) expense includes all the expenses incurred in the selling of the products of the company whether direct or indirect along with the entire general and the administrative expenses during an accounting period under consideration such as advertisement expenses, sales promotion expenses, marketing salaries, etc.read more and depreciation expenses from the gross profit. This line item is known as the operating profit because the company generates this amount from its operation. This income does not include anything generated with financial leverageFinancial LeverageFinancial Leverage Ratio measures the impact of debt on the Company’s overall profitability. Moreover, high & low ratio implies high & low fixed business investment cost, respectively. read more.

Please note that this Income Statement example of Google includes Research and development cost as an Operating Expense.

Google - Income Statement - EBIT

source: Alphabet (Google) SEC Filings

  • Operating Profit of Google was $23,716 million in 2016 and $19,360 million in 2015.

#7 – Interest Expenses

These are the interest paid by the company in a particular period for the total debt of the company. It includes interest for short term debt, long term debtLong Term DebtLong-term debt is the debt taken by the company that gets due or is payable after one year on the date of the balance sheet. It is recorded on the liabilities side of the company's balance sheet as the non-current liability.read more, and also interest payables.

Below is the snapshot of the Income Statement example – Googles Interest IncomeInterest IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. read more and Interest Expense.

Google - Income Statement - Interest Income expense

source: Alphabet (Google) SEC Filings

#8 – Net Profit

Net Profit is arrived at by deducting interest expenses and taxes of a company from the operating profit of the company.

Please see the below Net Income calculation from Google’s Income Statement example

Google - Income Statement - Net Income

source: Alphabet (Google) SEC Filings

  • Google’s Net Income was 19,478 million in 2016 and 15,826 million in 2015.

Conclusion

The income statement presents a basic summary of the company’s income and expenses. It is very important to understand each line item to figure out the prospects of a company. The items like sales, net profit, operating profit, interest expenses are the variables for financial ratiosFinancial RatiosFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on.read more that are tracked to analyze a particular company. Trends need to be tracked for most of the line items to gauge which way the company is improving and where it is slipping.

This article has been a guide to Income Statement Basics. Here we discuss the basic components of Income Statement (Sales, COGS, SG&A, EBIT, D&A, Interest Expense, Net Profit) with the help of practical examples. You can learn more about accounting from the following articles –

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