Summary Understanding of Income Statement and Cash Flow Statement
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Course
Finance
Institution
Indian Institute Of Management
Understanding the Income Statement and Cash Flow Statement is crucial for gaining insight into a company's financial health. The Income Statement provides a summary of a company's revenues and expenses over a specific period, indicating its profitability. On the other hand, the Cash Flow Statement ...
Financial Accounting and Analysis
Prof. Padmini Srinivasan
Week 3: Handout
HANDOUT FOR WEEK 3
UNDERSTANDING THE INCOME STATEMENT
(Profit and loss statement)
Introduction
The financial account system generates and important report that captures the financial
performance of the company called as the “Income statement” or the Statement of profit and
loss.
Income statement is measured with reference to a period of time. This period of time is
usually for a year. Performance reports are also prepared for periods less than a year when
firms provide interim reports for quarters or half years. For internal purpose this statement
can be prepared every month as well.
It depicts the financial performance of the firm in terms of incomes earned and expenses
incurred. This is very similar to the flow of water into and out of a dam measured with
reference to a period of time.
An income statement presents the revenue earned during the period and the expenses
incurred in generating that revenue.
Net Income represents the excess of revenue over expenses over a period of time.
Net Income = Revenue – Expenses
The income statement presents a summary of the operating and financial transactions, which
have contributed to the change in the owners' equity during the accounting period. Revenues
are transactions that augment owners' equity and expenses are transactions that diminish
owners' equity.
Income:
Income is defined in the standards as: Income is the increases in economic benefits during
the accounting period in the form of inflows or enhancements of assets or decreases of
liabilities that result in increases in equity (Retained earnings) other than those relating to
contributions from equity participants.
Income comprises both the operating income as well as the non-operating income. Operating
income constitutes the revenue generated from the core activities of the business, i.e. it can be
either sale of goods or rendering of services. Apart from the primary income, a company can
generate income from other sources like generating income from sale of assets, interest
income and other income from non-operating activities.
, Financial Accounting and Analysis
Prof. Padmini Srinivasan
Week 3: Handout
Operating expenses are incurred to run the core business of the firm. It comprises of items
like the cost value of goods or services sold and general administrative, selling and
distribution expenses.
Non-operating income /gain comprises of income generated from sources other than the core
activities of the firm and can be further broken down into income and gains. For example, for
a firm engaged in tourist taxi service, income earned from investment will be considered as a
non-operating income (other income) and profit earned on sale of cars will be non-operating
gains. Non-operating expense/loss comprises of the losses or and expenses are relatable to
sources other than the core business. For a tourist taxi firm, examples of non-operating
expenses will be loss on sale of equity shares held as investment will be a non-operating loss.
Revenue: The term Revenue means the price charged to customers for goods sold or
services rendered. It is the inflow of economic benefits (cash, receivables, other assets)
arising from the ordinary operating activities of an entity
To illustrate, a retail store generates revenue by selling the goods. A service enterprise gets
revenue by charging fees for the services provided. When goods are sold or services
performed, the resulting revenue is in the form of cash or accounts receivable. Revenue is not
necessarily “cash” flowing into a business within same Accounting year. Rather, it is the
amount “earned” during the period. It can be in cash or kind.
Expenses: Expenses in general terms mean the costs incurred for generating revenue. They
are the cost incurred in the normal course of business operations. The expenses can range
from acquiring raw materials, production costs, administrative expenses like employee
salaries, utilities expenses; other overhead expenses used are the common examples of
business expenses.
There are 3 important concepts related to the income statement. These are Realisation,
Accrual and Matching Concept.
The Realization Concept
An important concept, the realization concept, indicates the amount of revenue that
should be recognized from a given sale. Revenue should be recognised only when the goods
are sold and when the services are provided. According to the realisation principle, a
revenue is recognised when the transaction generating the revenue takes place and not when
the cash for the transaction is received. To illustrate this principle, let us consider an
example. Suppose a firm sells goods worth $10,000 on credit to a customer. The revenue is
recognised when the sale takes place even though cash may be received later. When the firm
receives cash, it will adjust its balance sheet by decreasing the receivables and increasing the
cash.
The Matching Concept
As noted earlier, the sale of merchandise has two aspects: (1) a revenue aspect, reflecting the
revenue realized, and (2) an expense aspect, that is incurred to earn the revenue
This principle requires that all the costs and expenses incurred should be identified and
matched against the related revenue earned during a time period. To summarise, all the
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