Definition
The income statement, also called the profit and loss statement, reports a business's revenue, expenses and resulting profit or loss for a period such as a month or a year. Presented by function, it runs from revenue through cost of sales and gross profit to operating expenses, finance costs, tax and net profit.
How it works
IFRS allows expenses to be classified by function (cost of sales, distribution, administration) or by nature (materials, staff costs, depreciation). Function shows margins more clearly; nature is simpler for small businesses. US GAAP practice is mostly by function. Whichever you use, keep it consistent between periods.
The subtotals tell the story. Gross margin shows pricing power and production efficiency; operating profit shows whether the core business pays for its overheads; net profit is what is left for owners after interest and tax. Comparing each with the prior year, or with budget, is more useful than any single figure.
Remember that profit is not cash. Under the accrual basis, a credit sale is revenue on delivery even if the customer pays in three months. The cash flow statement bridges the gap.
Formula
Gross profit = Revenue - Cost of sales
Operating profit = Gross profit - Operating expenses
Net profit = Operating profit + Other income - Finance costs - Income tax
Example: income statement by function
A distributor's year: 500,000 of revenue produces a net profit of 38,000, a 7.6% net margin.
| Line | Amount |
|---|---|
| Revenue | 500,000 |
| Cost of sales | (320,000) |
| Gross profit | 180,000 |
| Distribution costs | (55,000) |
| Administrative expenses | (70,000) |
| Operating profit | 55,000 |
| Finance costs | (7,000) |
| Income tax | (10,000) |
| Net profit for the year | 38,000 |