What is an Income Statement?

An income statement (also known as a profit and loss statement) is a financial statement that shows a company’s income and expenditures. It is one of three important financial statements that incorporated companies are legally required to submit every financial year along with their balance sheet and cash flow statement.

By focusing on revenues, expenses, gains and losses, an income statement provides an overview of a company’s profitability (or lack thereof), showing the company’s profit or loss over a given period. Income statements can be used to calculate net income by adding together revenue and capital gains before deducting a combination of operating expenses and losses. It also incorporates the Cost of Goods Sold (COGS), making it suitable for calculating gross profit.

How are income statements used?

Income statements are used both internally and externally. They are used by business leaders to inform financial decision-making, identifying areas of excess spending or loss-making activities that undermine company profits so that they may take appropriate action.

External parties also use income statements to analyse the financial health of a company. For instance, a bank or lender may interrogate historic income statements alongside other forms of business accounting to ascertain the company’s risk level when applying for a business loan. Likewise, prospective investors and shareholders can identify whether a company is worth investing in by analysing its income statements. Even competitors can use these statements to determine the state of a competing company’s financial performance relative to their own.

What is included in an income statement?

An income statement contains a range of information pertaining to a company’s finances. It has four main components: revenue, expenses, gains and losses. All of these combine to provide the data necessary to determine the company’s net profit for the period.

Although there is no prescribed format for income statements, an income statement will usually include the following:

Total revenue and gains

This includes sales revenue and other income from core business activities, also known as operating revenue, as well as gains from other sources such as the sale of assets, interest on finance or operating and maintaining a system.

Cost of Goods Sold

COGS covers all costs associated with bringing a product to market, although it does not include indirect expenses such as rent, utilities and managerial pay.

Gross profit

Gross profit is derived by calculating total sales revenue and then deducting the cost of goods sold.

Expenses

An income statement also includes all expenses that are not included in COGS such as the purchase of new assets, employee payroll, pensions contributions, training costs, research and development costs, consultant’s fees or legal expenses.

Depreciation

Other losses are included in the income statement, such as the depreciation and amortisation of assets as they lose their value over time.

Tax

Income or corporation tax will typically be accounted for in order to ascertain net income.

Income statement FAQs

How is an income statement different to a balance sheet?

Although an income statement and a balance sheet contain much of the same information, they offer slightly different perspectives. A balance sheet provides a snapshot of a company’s finances at a specific point in time, while an income statement tracks financial performance over a period of time.

What’s the difference between an income statement and a cash flow statement?

A company’s cash flow statement and its income statement tell two halves of the same story. While a cash flow statement shows how profit and loss flow through the company over time, an income statement gauges a company’s financial performance through its gains, losses and profits.

Do sole traders need to produce an income statement?

Unlike incorporated companies, sole traders are not legally required to produce an income statement. However, they do need to comprehensively account for their profit and loss when filling out their annual tax returns.