Financial Statements: Income Statement, Cash Flow Statement, and Retained Earnings Statement

The Income Statement

  • Summarizes revenues generated and expenses incurred over a specific period (year, quarter, month).
  • Also known as the Profit/Loss Statement or P&L.

Income Statement Structure

The general structure of the income statement is as follows:

  • Net Sales
  • - Cost of Goods Sold
  • Gross Profit
  • - Operating Expenses
  • - Depreciation Expense
  • Operating Profit
  • - Interest Expense
  • Profit Before Taxes
  • - Taxes
  • Net Income

Net Sales

  • Net Sales = Gross Sales - (Returns + Allowances)
  • 'Top line' refers to gross sales (revenues); 'top-line growth' indicates an increase in gross sales.

Cost of Goods Sold (COGS)

  • Direct costs associated with the manufacture or sale of a product.
  • For retailers: cost of materials purchased for resale.
  • For manufacturers: includes labor, manufacturing overhead, and depreciation related to production.
  • Unless specified, firms are assumed to be retailers.

Gross Profit

  • Gross Profit = Net Sales - Cost of Goods Sold
  • The gross profit margin is calculated as Gross Profit / Sales. It represents funds available to cover operating expenses.

Operating Expenses

  • Expenses incurred in the normal course of business, excluding COGS.
  • Includes advertising, repairs, maintenance, R&D, SG&A, and management salaries.

Depreciation/Amortization Expense

  • Non-cash expenses reflecting the 'wearing out' of fixed and intangible assets.

Operating Profit

  • Also known as Operating Income or Earnings Before Interest and Taxes (EBIT).

  • Operating Profit = Gross Profit - Operating Expenses - Depreciation Expense

Profit Before Taxes

  • Also known as Earnings Before Taxes (EBT).
  • Profit Before Taxes = Operating Profit - Interest Expense

Net Income

  • Also known as Earnings; often referred to as the 'bottom line'.
  • Net Income = Profit Before Taxes - Taxes
  • A standard measure of a company’s profitability.
  • Net income is either paid out as dividends or added to retained earnings.

Intel Income Statement Example

An example highligting the basic structure of the income statement with an example amount values:

  • Net sales: 3,162,000
  • Cost of goods sold: 2,433,000
  • Gross profit: 729,000
  • Operating expenses: 417,000
  • Depreciation: 78,000
  • Operating profit: 234,000
  • Interest expense: 64,000
  • Earnings before taxes: 170,000
  • Taxes: 51,000
  • Net income: 119,000

Comparative Income Statement Example

Showing 2018 vs 2017:

  • Net sales:
    • 2018: 1,500.0 (100.0% of sales)
    • 2017: 1,435.0 (100.0% of sales)
  • Variable operating costs (82% of sales):
    • 2018: (1,230.0)
    • 2017: (1,176.7)
  • Gross profit:
    • 2018: 270.0
    • 2017: 258.3
  • Fixed operating costs, less depreciation:
    • 2018: (90.0)
    • 2017: (85.0)
  • Earnings before interest, taxes, depreciation, and amortization (EBITDA):
    • 2018: 180.0
    • 2017: 173.3
  • Depreciation:
    • 2018: (50.0)
    • 2017: (40.0)
  • Net Operating income (NOI) = Earnings b/f interest and taxes (EBIT):
    • 2018: 130.0
    • 2017: 133.3
  • Interest:
    • 2018: (40.0)
    • 2017: (35.0)
  • Earnings before taxes (EBT):
    • 2018: 90.0
    • 2017: 98.3
  • Taxes (40%):
    • 2018: (36.0)
    • 2017: (39.3)
  • Net income:
    • 2018: 54.0
    • 2017: 59.0
  • Preferred dividends: 0.0
  • Earnings available to common stockholders (EAC):
    • 2018: 54.0
    • 2017: 59.0
  • Common dividends:
    • 2018: (29.0)
    • 2017: (27.0)
  • Addition to retained earnings:
    • 2018: 25.0
    • 2017: 32.0

Statement of Cash Flows

  • Cash generated by a firm differs from what is reported on the Income Statement due to factors like depreciation, increased/retiring debt, and investments.
  • The statement of cash flows reports cash inflows and outflows, categorized into three activities.

Sections of the Cash Flow Statement

  1. Cash flows from operating activities
  2. Cash flows from investing activities
  3. Cash flows from financing activities

Cash Flows From Operations

  • Net Income + Depreciation
  • Changes in Accounts Receivable (A/R) and Accounts Payable (A/P)
  • Changes in Inventory
  • Changes in Pre-paid and Accrued Balances

Cash Flows From Investment Activities

  • Transactions involving buying and selling:
    • Property, Plant, and Equipment (PP&E).
    • Investments (current and non-current).
    • Notes Receivable (current and non-current).

Cash Flows From Financing Activities

  • Funds secured by borrowing or issuing stock.
  • Cash inflows:
    • Cash received from issuance of common stock.
    • Cash received from issuance of bonds.
    • Cash received from issuance of Notes Payable (N/P).
  • Cash outflows:
    • Paying off bonds.
    • Repurchasing stock.
    • Payments of N/P.
    • Payments of dividends.

Statement of Cash Flows Example

  • Cash Flows from Operating Activities:
    • Net income: 54.0
    • Additions to net income:
      • Depreciation: 50.0
      • Increase in accounts payable: 15.0
      • Increase in accruals: 5.0
    • Subtractions from net income:
      • Increase in accounts receivable: (20.0)
      • Increase in inventory: (70.0)
    • Net cash flow from operations: 34.0
  • Cash Flows from Long-Term Investing Activities:
    • Acquisition of fixed assets: (80.0)
  • Cash Flows from Financing Activities:
    • Increase in notes payable: 5.0
    • Increase in bonds: 45.0
    • Dividend payment: (29.0)
    • Net cash flow from financing: 21.0
  • Net change in cash: (25.0)
  • Cash at the beginning of the year: 40.0
  • Cash at the end of the year: 15.0

Statement of Retained Earnings

  • Balance of retained earnings, December 31, 2019: 260.0
  • Add: 2020 net income: 54.0
  • Less: 2020 dividends paid to stockholders: (29.0)
  • Balance of retained earnings, December 31, 2020: 285.0