About Brian DeChesare
Brian DeChesare is the Founder of Mergers & Inquisitions and Breaking Into Wall Street. In his spare time, he enjoys lifting weights, running, traveling, obsessively watching TV shows, and defeating Sauron.
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: 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:
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:
Besides these specific sections, there are also summary lines worth noting:
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.).
Monster Beverage has a good, simple example of an Income Statement.
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:
In real life, you will see more complex line items on the Income Statement.
For example:
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).
We receive many questions about why Item X appears on the Income Statement while Related Item Y does not. For example:
The short answer is that you should think about the requirements to appear on the Income Statement:
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.
In financial models, there are two main options for forecasting items like Revenue, COGS, and Operating Expenses on the Income Statement:
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:
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:
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:
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.
Brian DeChesare is the Founder of Mergers & Inquisitions and Breaking Into Wall Street. In his spare time, he enjoys lifting weights, running, traveling, obsessively watching TV shows, and defeating Sauron.