Regulatory bodies and exchanges require companies to submit their income statement periodically on top of the annual financial statement in an effort to increase transparency. Income statements aim to provide investors with necessary insights, but how exactly do these periodic financial documents accomplish this?
We explain what income statements are and how the information they reflect assist investors in making better informed decisions.
What is an income statement?
An income statement is a financial document that reflects a company’s financial performance over a specified period. Income statements allow companies to keep track of their income and expenses in order to work out the earnings per share (EPS)—the amount investors are entitled to receive for each common share they own.
What makes up an income statement?
Similar to cash flow statements, income statements provide information on the movement of a company’s finances but with the inclusion of depreciation and other non-cash items. Companies periodically provide a list of income and spending that are distributed among the four core components of income statements. These are: earnings, expenses, gains and losses.
- Earnings refer to income generated by a company from both operating and non-operating revenues. This means earnings include income that the company generates from its core business activities and any secondary activities such as interest from investments and royalties.
- Expenses refer to all spending in relation to core business activities, such as the purchase of raw materials and employee salaries, and secondary activities, such as loan and interest payments. Expenses also include the costs for non-cash transactions such as depreciation and amortisation.
- Gains, also known as ‘other income’, refer to income generated by the company through non-business activities, such as realised income from selling used equipment or one of its facilities.
- Losses refer to financial losses that companies incur from selling long-term assets. For instance, a $10 million facility depreciates in value and could only be sold for $7.7 million. Likewise, companies may consider expenses that go toward responding to lawsuits as losses.
How do income statements benefit investors?
Companies and listed entities are required by law to periodically submit income and financial statements, as stated under the Corporations Act. This is done not only to promote transparency but to provide investors with valuable insight on a company’s profitability.
Benefits of income statements also include the following:
- Provide insights on how well a company is able to manage the finances of its primary business.
- Allows investors to evaluate how well a company manages non-core aspects and assets of the business.
- Provide details on a company’s revenue, expenses, gains and losses, including pre and post-tax figures.
- Shows the computation down to the EPS so they have an idea of where the company pulled the dividend value from.
- Gives an objective idea about the company’s potential for growth.
Awareness of the information above can help investors make informed investment decisions, especially for value and passive investors, and manage investment risks.
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About the author
Join The Nest Egg community
We Translate Complicated Financial Jargon Into Easy-To-Understand Information For Australians
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