Overview:
The income statement shows the information related to revenues, expenses, and profits of an entity for a specific period. That is what the information you can obtain from the income statement.
You can use this information to analyst and assess the performance of the entity again similar size in the industry or other purposes.
However, as you don’t have much experience and educational background in accounting and finance, you might feel the struggle in reading and analyst your entity income statement while you are in the position that can ask your executive about their performance during the year.
In this article, I will teach you how to read and analyst income statement of your entity like you have a very good background in accounting and finance.
Period it covered:
I assume you know the income statement that you hold in your hand is for which company.
That is the first step and make sure you are not confusing about it. And, other very important information, but most people especially non-accountant management miss is the period in which income statement cover for and that is part of the reason why income statement is different from the balance sheet.
The income statement shows the entity’s performance over the period. For example, it over from 01 Jan 2016 to 31 December 2016 while balance sheet telling you how much assets, liabilities, and equity at the reporting date.
This is very important because you might compare the six moths’ income statement to a one-year period income statement which could lead to making significant differences in performance.
So, make sure that when you compare the performance two entities, you use the same period.
A different template, different meaning:
Well, this is a bit difficult for you to understand the template or format that use to prepare an income statement.
But here is the basic that I can tell you which is very important for your understanding of the income statement.
Basically, there are two templates that use by the entity to prepare its income statement and either one is correct and allows by an accounting standard.
The first one we called a single-step income statement and the second one we call two-step income statement.
The single-step statement, at the revenue part, it includes all kind of revenue no matter it is from the operation and non-operation.
Why is it important? Well, the thing is when you assess the financial performance of the entity, what you really want to know is how well the performance of the entity is.
And the information that helps you to assess this is the revenue from the operation. The one from non-operation like revaluation gain or gain from translation different is not important for performance assessment.
So, be careful about using information income statement.
Do some math: Check with income statement itself and others statements:
Sometime, you might want to do some math on the income statement. Just because it is carefully prepared by an accountant, it does not mean it always mathematically correct.
Based on experience, I noted that there are at least three to five among fifty statements that are mathematically incorrect.
For example, Revenue less Cost of Goods Sold is not equal to gross profit. Gross profit less operating expenses are not equal to the net income that put in the statement.
Another thing you can do to check if the income statement is correct is to check with the balance sheet, statement of change in equity, and cash flow statement. For example, the difference between retaining the earning of the comparative balance sheet is equal to net income.
Question like a pro:
Normally, the income statement is prepared by comparing at least two years with the same period of time.
For example, the 2015 income statement figure is compared with the 2016 figure. This is required by accounting standards. In this part, you might want to question something like why the revenue increases or decreases.
Sometimes the revenues are increase or decrease might not because of good sales performance. But because of the accounting technique. Management might try to manipulate the revenue figure by over or under recognize sales revenues.
You might also check why there is a gross profit ratio from the current year to the previous year is different. If the cost structure and strategy is not changing, even the sales change but the gross profit ratio might not change.
Question CEO about this and you can also question them about this in net profit ratio. The net profit ratio is a bit different since it is effective by operational cost.
Understand the key items in the income statement:
They’re some kind of revenue and expenses that report in the income statement might seem to be not related to the entity and you should question it.
For example, there is a large disposal of assets during the year and we know that the business is growing. This is might be because of the replacement of old assets due to the technology change.