The Statement of Income

The second financial statement is the statement of income (see Figure 4.2). This is the statement that shows the results of operations over a period of time, usually a full year or the latest quarter. The statement of income is also called the profit and loss statement (or P&L).

The statement of income is divided into several distinct groups. At the top is the total of sales or revenues for the period being reported. This may be shown as a single line item (gross sales), a detailed breakdown by product or service area, or a gross amount reduced by returns and allowances (net sales).

Next is a group called cost of sales. This includes all costs directly associated with the production of sales (as opposed to expenses that cannot be directly assigned). (Rent, for example, will not rise or fall as sales rise or fall, so it is an expense rather than a cost.) The cost of sales usually is reported as a single line, and is subtracted from sales or revenues. Total cost of goods sold is subtracted from sales to arrive at the period's gross profit.

The next group involves some breakdown of selling, general, and administrative expenses. Some companies make a distinction between selling and general expenses; others have one section for all expenses without making a distinction. If the list is extensive, the details are provided in a supplementary schedule and only a single-line total is included on the financial statement itself.

FIGURE 4.2 The Statement of Income

 

When all expenses are subtracted from the gross profit, the remaining value is operating profit. Adjustments are made to this for other income and expense, meaning nonoperating transactions. These may include interest income or expense, or profit or loss from foreign currency exchange, for example. After these adjustments are made, the remaining value is pretax profit. This is not the true bottom line, however. The company probably owes income taxes on its profits, so tax liability is deducted to arrive at net profit. In the interest of consistency in comparisons, the actual net profit should be used for all ratio analysis calling for net profit. A word of caution, however: The terminology suggested here is not used universally. In some instances, net profit might refer to operating profit without adjusting for other income or expense, and without calculating income tax liabilities. You should ensure that your own analysis is consistent between companies; adjustments might be necessary if and when the same terms or definitions are not being used.

Like the balance sheet, this statement of income is highly simplified. Companies report in comparative form, showing results for three successive years, often including percentages from sales (100 percent) down to the bottom line, or with breakdowns by major subsidiary operations.

KEY POINT

The statement of income summarizes the transactions over a period, such as one full year or the latest quarter. For consistency and uniformity in reporting, the ending date of that period corresponds to the date reported on the balance sheet.