The Income Statement: Definition, Examples, and Interpretation

Income Statement Definition: In accounting, the Income Statement shows a company’s revenue, expenses, and taxes over a PERIOD, such as 1 year, 1 quarter, or 1 month; items must correspond to a delivery or allocation in the period and affect the business income available to the common shareholders of the business (i.e., the owners).

The Income Statement is critical in almost any financial analysis, including 3-statement projection models, debt vs. equity analysis, leveraged buyout models, merger models, and more.

It even comes up in industry-specific modeling in fields like infrastructure and real estate because assets like offices, warehouses, solar plants, and wind farms also have Income Statements.

You can find plenty of online sources that present boring definitions, so we’ll focus here on the real-life implications and uses of the Income Statement, including how it works in financial models and what you need to know about it in interviews.

Here are the files and resources for this tutorial:

Files & Resources:

• Income Statement – Summary and Presentation Slides (PDF)
• Simple Income Statement for an Online Business (XL)
• Monster Beverage – Financial Statements (PDF)
• Monster Beverage – Excel Version of the Balance Sheet in a Financial Model (XL)

Video Table of Contents:

• 0:00: Introduction
• 0:39: The Short Version
• 5:43: Part 1: More Advanced Line Items
• 7:24: Part 2: Why Does Item X Appear on the IS?
• 9:50: Part 3: Income Statement Forecasting
• 11:46: Part 4: The Income Statement in Interviews
• 14:10: Recap and Summary

What is the Income Statement? What Are Its Different Sections?

As stated above, the Income Statement shows a company’s revenue, expenses, and taxes over a PERIOD, such as 1 year, 1 quarter, or 1 month.

If we look at a very simple company, such as one that provides online courses and coaching services, the Income Statement might look like this:

The main sections in a standard Income Statement include:

• Revenue: This represents net sales across all the company’s segments. So, if a company sells and delivers 100,000 widgets for $10.00 each in the period, its revenue is $1 million. This is based on delivery, not cash collection, at least for large/public companies.
• Cost of Goods Sold (COGS) or Cost of Sales: These represent the “per unit” costs of selling and delivering the products and services, so they are 100% variable. These might represent raw material and shipping costs for physical products; for services and digital products, they might consist of the labor costs to deliver and support the product/service, such as the coaches who get paid to do the coaching.
• Operating Expenses: These are the costs of anything that cannot be linked to individual units sold, such as paying for employees, rent, advertising, utilities, insurance, accounting/audit, and other services. Many of these expenses are fixed, but some also have a variable component. For example, rent increases as the company’s revenue increases because it needs more space as it hires more employees – but it may not step up directly in line with revenue.
• Other Income and Expenses: Anything “miscellaneous” goes here, and so do items like interest expense paid on Debt and interest income earned on cash or investments. This area reflects the company’s “side activities” and its financing costs.
• Taxes: This is what the company owes to the government based on its revenue and expenses in the period.

Besides these specific sections, there are also summary lines worth noting:

• Gross Profit: Equal to Revenue minus COGS, this tells you how much additional potential profit the company could make from each unit sale, before fixed expenses
• Operating Income: This tells you how much the company earned from its core business, before taxes, side activities, and financing costs. It’s one of the key inputs in the EBITDA calculation as well.
• Net Income: How much profit did the business generate after expenses and taxes? This is the literal “bottom line” on the Income Statement, but there are some variations, such as Net Income to Common.

You can also make these numbers into margins by dividing them by Revenue.

For example, the Gross Margin equals the Gross Profit / Revenue and indicates the company’s profit percentage on each sale (before fixed expenses, taxes, etc.).

Real-Life Income Statement Example and Template

Monster Beverage has a good, simple example of an Income Statement.

• Monster Beverage – Financial Statements (PDF)
• Monster Beverage – Excel Version of the Income Statement in a Financial Model (XL)

Here’s an image of the company’s version:

And here’s our version with several changes:

We tend to make a few changes to company-provided Income Statements:

1. Level of Detail – In some cases, such as with the Revenue here, we show the components in more detail. But in other cases, we simplify and consolidate, such as if the company records many small/insignificant line items that do not drive the business.
2. Signs – We prefer to record expenses and taxes with negative signs and income sources with positive signs. This makes linking and checking the model easier because you do not have to think about whether to add or subtract an item. Everything is simply “added,” and each line has the correct positive or negative sign.

More Advanced Income Statement Nuances and Line Items

In real life, you will see more complex line items on the Income Statement.

For example:

• Gains and Losses if a company sells an asset in the period.
• Depreciation & Amortization on a company’s long-term operational assets.
• Impairments and Write-Downs if a company believes the values of some of its assets have declined.
• Preferred Dividends, which are like the “interest expense” but on Preferred Stock rather than Debt – and are not tax-deductible (unlike interest).
• Net Income from Associates or Equity Investments and Net Income Attributable to Noncontrolling Interests: These relate to much more complicated topics; please see our tutorials on the equity method of accounting and consolidation accounting. But in short, they relate to the income from a company’s partial ownership in other companies.

Of this list, Depreciation & Amortization is easily the most important topic for interviews, case studies, and the job itself.

It represents the allocation of a company’s previous capital spending (Capital Expenditures or Intangible Purchases) over many years.

When a company buys a factory, it might be useful for 10, 15, or 20+ years, so it can’t record the entire expense upfront on its Income Statement.

Instead, it records the cash spent for the factory on its Cash Flow Statement and then allocates the spending over its useful life in the Depreciation line on the Income Statement.

The tricky thing is that in real life, Depreciation & Amortization could appear as a separate line item, embedded within other line items, or a mix of both.

You must look at the Cash Flow Statement to get the true number.

Once you have it, you could modify the Income Statement to reflect the total D&A in a separate line, but it’s not necessary if you understand that expenses may be embedded within other line items:

With the other items, Gains and Losses and Impairments and Write-Downs all correspond to events in the current period and affect the income available to the owners, so they all appear on the Income Statement.

Preferred Dividends require a bit more explanation (see below).

Why Does Item X Appear or Not Appear on the Income Statement?

We receive many questions about why Item X appears on the Income Statement while Related Item Y does not. For example:

• Why do Preferred Dividends appear on the Income Statement while Common Dividends do not? (They’re on the Cash Flow Statement)
• Why does the Interest Expense appear on the Income Statement, but Debt Issuances and Debt Principal Repayments do not? (They’re on the Cash Flow Statement)

The short answer is that you should think about the requirements to appear on the Income Statement:

1. Items must correspond to a delivery or allocation in the period.
2. Items must affect the income available to the common shareholders of the business (i.e., the owners).

With the first question, Preferred Dividends directly reduce the income available to the owners, which is why they are deducted in the Net Income to Common calculation.

The Preferred Stockholders always get paid first, before the equity owners, and these Preferred Dividends directly reduce how much could be distributed to the owners in the period.

Common Dividends also represent a payment made in the current period, but they do not affect the income available to the owners – because they are the distribution to the owners.

With the second question, Debt Issuances and Debt Principal Repayments correspond to longer-term items because Debt typically remains outstanding for many years.

If a company issues Debt or repays some of it, that doesn’t just affect the current period – it changes the company’s obligations and Interest Expense going forward.

By contrast, the Interest Expense itself applies only to the current period and doesn’t affect the future (with some exceptions, such as PIK Interest).

Also, these Debt issuances and repayments do not directly affect the income available to the owners in the current period.

Therefore, Debt issuances and principal repayments are always shown on the Cash Flow Statement.

Income Statement Forecasting in Financial Models

In financial models, there are two main options for forecasting items like Revenue, COGS, and Operating Expenses on the Income Statement:

1. Option #1: Simple Percentages – For example, you could make Revenue grow at 5% or 10% per year, say that COGS represent 50% of Revenue and that Operating Expenses represent 20% of Revenue. This method “works” for quick/simple models but is not necessarily ideal for making real-life decisions.
2. Option #2: Unit Economics – For example, the company sells 100,000 widgets per year at $10 per widget, and it costs $3 per widget to produce and deliver each one. The company also needs 5 employees to support this business, and each one costs $100,000 per year.

You could also mix and match the methods, using unit economics for some line items, such as Revenue, but simple percentages for others, such as expenses.

We tend to take a “middle of the road” approach, using the following guidelines:

1. 30-to-60-Minute Models – We might use simple unit economics for Revenue but will often use percentage estimates for everything else.
2. 2–to-3-Hour+ Models – We attempt to use “unit economics” wherever possible, depending on the information available.

In general, it’s easier to create unit-level forecasts for Revenue than for expenses because many companies do not break out employees or spending by category.

Here’s an example from the Monster Beverage Model:

What You Need to Know About the Income Statement in Interviews

In investment banking interviews, you should know the basic definitions of the financial statements, the most common line items that appear on the Income Statement, and how simple changes, such as an addition product sale, affect it.

The Income Statement is especially important in accounting questions because you should always START with it and then move to the other statements.

That’s because you need the Net Income at the bottom of the Income Statement to “feed into” the Cash Flow Statement; the Ending Cash on the CFS then flows into the Balance Sheet.

Even if you get a question about a non-Income Statement line item, you should still start there and state explicitly that nothing changes.

AVOID mentioning whether the change affects Gross Profit, Operating Income, or other “in-between” line items on the Income Statement.

Focus on how it affects Pre-Tax Income and Net Income because you need the Net Income to explain the other statements.

As an example, consider this question:

“What happens when a company’s Accounts Receivable balance increases by $100? Assume no corresponding expenses.”

You would always start with the Income Statement and then move to the others:

• Income Statement: This means the company has delivered a product worth $100 but not collected the cash yet, so Revenue is up by $100, Pre-Tax Income is up by $100 (since there are no expenses), and Net Income is up by $75 at a 25% tax rate.
• Cash Flow Statement: Net Income is up by $75, but the company hasn’t received the cash yet, so the Change in AR is negative $100, and Cash at the bottom is down by $25.
• Balance Sheet: Cash on the Assets side is down by $25, and AR is up by $100, so Total Assets are up by $75. Equity on the L&E side is up by $75 due to the increased Net Income, so both sides are up by $75 and balance.

If you had not started with the Income Statement, you would not have been able to walk through the other changes since you would not have had the Net Income figure.

This is especially important here because you might be tempted to start with the Balance Sheet since AR is a Balance Sheet line item – but that is not correct!

You need the Income Statement first because this change represents a specific scenario that affects Revenue and Net Income on the Income Statement.