Understanding the Income Statement
An income statement shows you a company’s profit and loss over time. These were again commonly known as profit and loss statements.
An income statement usually shows:
- Income
- Cost of Goods Sold
- Total profit
- Expense
- Profit for tax
- Tax
- Net earnings
Income is the money a company takes out; subtract the cost of goods sold to find the total profit. Subtract the expenses from the total gain and arrive at the result before tax (EBT). Payments may include marketing, advertising, promotion, general and administrative costs, interest charges, depreciation, and amortization, spreading the cost of assets over time. The tax amount is subtracted from EBT to calculate a company’s net income or loss.
You can use these numbers differently to understand a company’s financial health.
What Can You Do With It?
Your profit and loss statement is an annual dipstick in the engine of your company. Is the net profit on par or below it? You want to maintain or even increase a positive result. You will have to adjust and act if there is a shortage. It is essential to talk to your financial advisor about, for example, cost aspects, price calculations, and purchasing benefits. You can also compare your data with that of entrepreneurs in your industry. Collect them from your trade association or bank.
Financing
Financiers like banks can extract valuable information from the profit and loss account and balance sheet. They do this with calculation formulas (key numbers). A financier needs these key figures to know whether your business is healthy. To assess this, a financier looks at your turnover and purchase data. He compares your figures with those of other companies in your industry.
Are you looking for financing? Then, make sure you have a realistic profit and loss account. Also, create a ‘B scenario’ with 15% less turnover. Purchasing and variable costs are adapting. The fixed expenses, such as rent and personnel, remain the same. Then, ask yourself whether you still have enough profit left below the line. Also, keep your budget in mind.
Financial insight
With your profit and loss account, you get financial insight. Use several calculation exercises from the Annual Accounts Manual, section ‘information about key figures.’ Or enlist the help of an expert such as a bookkeeper or accountant. With knowledge about your figures, you are a good discussion partner for them and, for example, financiers.
Evidence for the tax authorities
You pay tax on your company’s earnings. How much depends, among other things, on the profit and the type of tax, income or corporate tax, and the tax regulations. You also have an administrative obligation. After checking your administration by the tax authorities, they determine the assessment. Do you have a correct profit and loss account? Then, you pay the correctly owed tax rate via an appraisal. An incorrect presentation of your profits will lead to a profit estimate by the tax authorities. In practice, this turns out to be unfavorable for you.
Profit statement inquiry
Investors can use income statement inquiry to calculate financial ratios that can compare the same or one company to another each year.
To illustrate, you can compare a company’s profits to its competitors by looking at total, operating, and net profit margins. Alternatively, you can compare one company’s earnings per share to another to show whether shareholders could earn EPS if each company shared net income. As part of the top line of revenue, each line of the up and down analysis report is called a vertical analysis. For example, you can use it to represent the relative size of various fees. Horizontal analysis helps you compare the same numbers in more than two periods and identify trends. Use horizontal analysis to show a profit before tax over the past three years.
Income statement conditions
The income statement has some limitations. Capital structure and cash flow are factors that make a company thrive or disrupt the use of quotes, which is the income statement’s limitation.
To illustrate, a company needs to estimate the depreciation of an asset. You can’t know the lifespan of a computer, copier, or business jet in advance. Or, if they face lawsuits, they must assess how they should be prepared to carry out their duties. By their very nature, estimates are interpretable.
Secondly, the limitation of the income statement is the deliberate over-or underestimation of numbers. Estimates are essential and may occur by accident, but they can also be made deliberately to increase or decrease metrics such as revenue or profit fraudulently.
Accounting rules can also be restrictive. It affects the number used in the comparison. When comparing income statements, consider that many companies may use the first-in, first-out (FIFO) principle to value inventory, while others may use the last-in, first-out principle.
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