Income Statement (Profit and Loss Statement)

1. Definition

The Income Statement, also known as the Profit and Loss (P&L) Statement, reports a company's financial performance over a specific accounting period.

While the Balance Sheet shows the financial position at a single point in time, the Income Statement details the flow of revenue and expenses, revealing how net income is generated during the period.

2. The Basic Equation

The fundamental logic involves subtracting total expenses from total revenue.

$$ \text{Net Income} = \text{Revenue} - \text{Expenses} $$

---

3. Key Components

It is structured from the "Top Line" (Revenue) down to the "Bottom Line" (Net Income).

A. Revenue (Sales)

• The total amount of money brought in from the company's core operations. This is the starting point of the statement.

B. Cost of Goods Sold (COGS)

• Direct costs attributable to the production of the goods sold (e.g., raw materials, direct labor).
• Gross Profit: Revenue minus COGS.

C. Operating Expenses (SG&A)

• Indirect costs involved in running the business (e.g., Selling, General, and Administrative expenses like rent, marketing, and salaries).
• Operating Income (EBIT): Gross Profit minus Operating Expenses. This represents the profit from core business operations before interest and taxes.

D. Net Income

• The final profit remaining after subtracting all expenses, including interest and taxes. This is the earnings available to shareholders.

---

4. Why It Matters

• Profitability Analysis: Determines whether the business model is viable and profitable (Revenue > Expenses).
• Margin Analysis: By calculating ratios like Operating Margin, investors can judge how efficiently management controls costs relative to sales.

5. Limitations

• Accrual Basis: Income is recorded when earned, not when cash is received. Therefore, "Profit is an opinion, Cash is a fact." A company can show high profits while running out of cash.
• Non-Cash Items: It includes expenses like depreciation and amortization, which reduce reported net income but do not impact immediate cash flow.