What is a Statement of Income?
The statement of income is one of the three primary financial statements used to assess a company’s performance and financial position at the end of an accounting period (the two others being the balance sheet and the cash flow statement). Specifically, it summarizes a company's revenues and expenses over the entire reporting period.
The statement of income is also known as a profit and loss (P&L) statement, statement of earnings, income statement, or statement of operations.
The basic equation on which an statement of income is based is Revenues – Expenses = Net Income.
How Does a Statement of Income Work?
All companies need to generate revenue to stay in business. Revenues are used to pay expenses, interest payments on debt, and taxes owed to the government. Once these costs of doing business are paid, the amount left over is called net income. Net income is theoretically available to shareholders, though instead of paying out dividends, the firm’s management often chooses to retain earnings for future investment in their business.
Statements of income are all organized the same way, regardless of industry. The basic outline is shown in the following example:
Statement of Income for Company XYZ, Inc.
for the year ended December 31, 2008
Total Revenue $100,000
Cost of Goods Sold ($ 20,000)
Gross Profit $ 80,000
Interest Expense ($ 10,000)
Income before taxes (EBT) $ 40,000
Taxes ($ 10,000)
Net Income $ 30,000
Number of Shares Outstanding 30,000
Earnings Per Share (EPS) $1.00
Why Does a Statement of Income Matter?
Anyone interested in active investing, picking stocks or investigating the financial health of a company must know how to read financial statements, including the statement of income. The importance of the information contained in the statement of income cannot be overemphasized.
A firm’s ability or inability to generate earnings over the long term is the key driver of stock and bond prices. Operating profit (EBIT) is the source of debt repayment, and if a company can’t generate enough EBIT to pay its debt obligations, it will have to enter bankruptcy or sell itself. Net income is the source of compensation to shareholders (owners of the company), and if a company cannot generate enough profit to compensate owners for the risks they’ve taken, the value of the owners’ shares will plummet. Conversely, if a company is healthy and growing, higher stock and bond prices will reflect the increased availability of profits.
Please note that earnings/net income/profits are not the same as cash or cash flow. It is possible for a firm to be profitable on the statement of income, but not be generating cash flow, and vice versa. To know a company’s cash flow, you will need to see its statement of cash flows.