Income statement
The financial statements of every listed company consist of three different statements that describe the company's finances from different perspectives. The balance sheet indicates the net assets of the company; the income statement, whether the company is profitable or not; and the cash flow statement whether the company generates cash flow.
The balance sheet, income statement and cash flow statement together describe the actual financial position of the company. This Analysis school article focuses on the income statement.
The income statement describes the company's result for a certain period of time
As an investor you should learn how to interpret the company’s income statement. Accounting is the language in which the company talks about its financial situation, and therefore it is crucial for an investor to be able to interpret it.
The main purpose of the income statement is to inform the company’s stakeholders about the profitability of the business. The income statement also provides comprehensive detailed information on, e .g., the business operations of the company, management efficiency, and possible leaks that could impair the company's performance.
While the balance sheet gives a snapshot of the financial situation of the company at a certain date, the income statement tells the company's result for a certain period of time. In principle, Finnish listed companies report their results four times a year, i.e. quarterly. There are exceptions, however, as some listed companies report their results only twice a year, i.e., every six months.
The structure of the income statement
The income statement always flows downwards and the first part is revenue, also called the top line. Revenue is the largest figure in the income statement, from which expenses are deducted as the income statement flows downward.
There may be (and is) some differences in the income statements of different companies, as income and expenses depend entirely on the nature of the company's business. There are, however, several general items or lines that are shown in all income statements. It is crucial for the investor to understand what is happening in the business of the company and why.
The company's income statement can be found in the Investors section of the company’s website in the latest earnings release. This is probably easiest to find by googling Company X investors.
Let us take a look at the most common items in the income statement using Puuilo as an example.
Revenue/Net sales
Revenue is the sum of the goods and/or services sold by the company during the reporting period. For example, Puuilo’s Q2 revenue was EUR 148.1 million. The figure does not as such provide much information to the investor on what the revenue consists of. Companies can therefore specify how revenue is generated in the notes to the earnings release.
Puuilo has specified this in section 4 of the notes, Income, stating that that revenue consists of sales in stores and online. Investors should, therefore, check the notes to better understand the company’s core business.
Other operating income
Other operating income can be, e.g., rental income or subsidies received. In accounting, this income cannot be included in the sales or financial income of the company and is therefore reported as other income. In most cases, other operating income is relatively small and thus not so relevant to the investor. For Puuilo, other operating income was EUR 0.2 million.
Materials and services
Materials and services are directly related to the formation of the company's revenue. Materials include materials, supplies and goods, such as raw materials for the company's manufacturing activities or purchases of goods for sale. Materials and supplies also include changes in inventories which describe changes in the value of inventories at the beginning and end of the accounting period. NB! However, the value of inventories is recorded in the company’s balance sheet. Services include external services, such as subcontracted services directly related to the business of the company. During the review period, Puuilo made purchases of EUR 95 million for sold products.
Personnel costs
Personnel costs include wages and salaries paid to employees. Personnel costs also include indirect personnel costs, which are divided into pension costs and other indirect personnel costs. Personnel costs are often one of the company's largest expense items. Puuilo’s personnel costs totaled EUR 14.3 million.
Other operating expenses
Other operating expenses can include an infinite number of different cost items that are not directly related to the company's sales volume. Typically these include marketing costs, accounting and auditing costs, rents of premises and phone bills. The company will usually specify other operating expenses in the notes found in the earnings release.
Depreciation and impairment
Depreciation and impairment include, e.g., planned depreciation of equipment, buildings and factories included in the company's balance sheet. Usually the company’s costs are shown as expenses in the income statement in the same financial year when the money has been used. However, for large investments, the costs are not immediately recognized in the income statement but with depreciation the company’s purchases are divided over several years. The income statement always includes depreciation representing one year.
Example:
Puuilo buys a new e-commerce warehouse that would cost EUR 30 million. Puuilo will use the warehouse for 15 years, which means that this large investment will not immediately be recognized as payable in the income statement. Therefore, the income statement will only include depreciation representing one year, which in this case would be 30/15 = EUR 2 million.
During the review period, Puuilo’s depreciation and impairment totaled EUR 6.2 million. It is important to note that in the IFRS 16 standard lease liabilities are also depreciated and this represents a considerable share of Puuilo’s depreciation.
Operating profit
When the costs of the income statement explained above are deducted from the company’s revenue or sales the result is the company’s operating profit. As the name suggests operating profit is the amount of profit the company made before interests and taxes. The operating profit depicts the operating result of the company. Puuilo’s Q2 operating profit was EUR 23 million.
Share in the net profit of associated companies and joint ventures
A company can own joint ventures or shares in companies. Puuilo does not have such associated companies and joint ventures but many companies do. Associated companies are referred to when a company holds 20-50% of the voting rights and/or has significant influence, but not control. However, an associated company is not part of the group.
Example:
If Company X holds 49% of the voting rights of Company Y, the amount of the profit or loss and the change in equity of Company Y corresponding to the holding (49%) is consolidated in the consolidated financial statements.
Financial income
Instead of leaving cash just laying in bank accounts the company can and often will invest its money in various targets. Financial income includes interest and financial income and income from investments in non-current assets. These include, e.g., debt securities and rental income from condominiums. The company can also obtain financial income from interest on late payments of accounts receivables. Puuilo had no financial income during the review period.
Financial expenses
In most cases, the company has debt on which it typically also pays interest. During the review period, Puuilo paid a total of EUR 1.4 million in financial expenses. Financial expenses typically include the company's interest expenses and other financial expenses, as well as impairment on investments in non-current assets and current financial securities. Financial expenses are typically interest expenses on loans. However, only the interest expenses and fees of loans are included in the income statement while loan repayments are included in the balance sheet.
Changes in fair value
Changes in fair value refer to the value of an assets such as inventories. If the value of the holding has to be increased or decreased due to, e.g., a changed market situation, these changes are shown in this row. However, changes in fair value do not affect cash flow, it is only an accounting technical matter. Puuilo had no changes in fair value during the review period.
Profit before taxes
The company's profit or loss before taxes that considers the company's financial income and expenses. Puuilo’s profit before taxes was EUR 21.6 million. To achieve the profit/loss for the period, i.e. under the row, the company must pay taxes on its earnings.
Taxes
Before the profit/loss for the period income taxes and direct taxes need to be included in the income statement. A Finnish listed company pays business income tax, or corporation tax, which is 20% of the company's profits. Puuilo paid EUR 4.3 million in taxes in Q2. Puuilo paid a total of EUR 8 million in taxes for the latest financial year, February 1, 2021 to January 31, 2022. A quick calculation shows that Puuilo’s income tax rate for the latest financial year was 8/31.9 = 26%.
Profit/loss for the period
The profit/loss for the period, or net profit/loss, is the bottom line of the income statement, which shows what is left below the line after all expenses and taxes. Puuilo’s profit for the period after taxes was EUR 17.3 million.
From an accounting point of view, the company's result is not transferred from one financial year to another, the events affecting income and expenses are only valid for a specific financial year. At the end of the financial year, when all income and expense accounts are closed, the net balance for the period, i.e. the profit/loss for the period, is transferred to the retained earnings account. When a new financial year begins, the income statement starts from zero again.
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