Interpreting Financial Statements: The Income Statement

The Income Statement is a very useful tool for understanding a company's performance. It is the most recognised financial statement because it shows whether the company is making profits or losses in a particular period e.g. month, quarter or year. It is also known as the profit and loss account.

In this article, we took the common components of this financial statement and what a reader can decipher from them. Whereas an income statement in a particular period is useful, the apparent value is derived when it is compared against prior periods or against an expectation such as a budget. One is then able to understand whether the company is performing to expectation or whether profitability is declining.

1. Sales/ Revenue

This is the top line of the income statement, it records earnings from sale of goods or services to customers. But when is a sale made?

Some of the corporate scandals reported in the press have been on manipulation of sales figures by recording sales too soon or too late.

2. Cost of Sales

These are the costs directly related to delivering the sale. It is the cost of producing or purchasing the goods or services sold by the business.

3. Gross Profit

This is the difference between sales and cost of sales. It is the first measure of profitability. The gross profit is what is applied toward meeting all the other expenses of the business. Rising margins could indicate increasing efficiency and vice versa.

4. Sales and Marketing Expense

Before a sale can occur, costs are incurred in creating product awareness through advertising; employing a sales force, brochures, e.t.c. Sales and marketing are one of the costs for acquiring a sale.

5. Administrative expense

Also known as overheads, these are the costs of the infrastructure necessary for the business to operate. They include rent, executive and administrative staff salaries, insurance, telephone and stationery among others.

6. Net Profit – The bottom line

The residual after deducting all business expenses from the gross profit. It is a net loss where expenses are more than the gross profit.