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Tuesday, March 22, 2011

Understanding the income statement

Income statements are one of three high profile accounting documents that summarize a companies earnings after expenses have been subtracted from revenue. The income statement is a statement of corporate profitability for a given time period whether it be quarterly or annually. Depending on whether a company is private or public, income statements are either made public via the securities and exchange commission in the case of public companies or private only made viewable by key corporate and ownership parties of interest.

The income statement is important because it demonstrates to corporate ownership how a company is performing, The income statement is also a necessary document for tax reporting requirements and is thus essential. These documents can also be audited by accounting organizations that do not have an obvious conflict of interest. Statements by auditors claiming the income statements comply with Generally Accepted Accounting Principles (GAAP) provide some credibility to the accuracy of the income statement.

Income statement items

The income statement is broken down into several lines on which positive or numerical values appear. These values may appear on a number of financial reports such as 10K annual reports, corporate prospectus', financial websites, or as downloaded or prepared on spreadsheets. The positive values are associated with income from revenue, and the negative values include cost of goods sold, expenses, depreciation, amortization and dividends paid. The retained earnings at the bottom of an income statement is often considered the most important number on the income statement, hence the phrase 'the bottom line'.  This number reflects the amount of revenue not spent by the company and may increase the net worth of the company and its shareholders. Some of the key values are listed below:

Sales or revenue: This is hopefully a positive number at the top of the statement
Operating expenses or cost of goods sold (COG): This is always a negative number
Net earnings after COG: This is the difference between Sales and COG
Depreciation and taxes: Also a negative number subtracted from Net earnings
Net earnings after depreciation and tax: Hopefully earnings are still positive
Dividends paid out: This is a negative number that is subtracted from the last net earnings.
Retained earnings: After all is subtracted and tallied what is left is either a net gain or loss for the company.

Not every income statement is exactly the same as some companies don't pay dividends or have property that depreciates. For example, a small sole proprietorship or partnership may have no shareholders or dividend paying shares. They may also have had a net loss the prior year which can be carried forward to the following years gains reducing or eliminating taxes. Thus, there are unique tax related and business type factors that influence what expenses a business has to put on its income statement.

Income statements are financial statements that report a companies revenue, expenses and retained earnings for a period of time. These documents are snapshots of a company's financial performance and can also be used for calculating financial profitability metrics such as return on revenue (ROE), and Profit Margin on Sales. Income statements are also required by the Internal Revenue Service in order to report taxable earnings if any. 

These financial statements can be prepared by accountants or those familiar with a company's finances and financial record keeping. Income statements are considered important documents by shareholders, corporation owners and taxation authorities because of their ability to illustrate a company's financial performance. Income statements are either prepared every 3 months of a fiscal year or 1 time a year or both quarterly and annually.