Chapter: 8 Understanding Financial Statements

Section: 3 Income Statement

Income statement, also known as statement of earnings is an integral part of financial statements issued by companies. Traditionally, performance is measured by the firms’ success in generating lucrative margins or income, well known as the “bottom-line” by the investors and business community. Thereby, until recent times the income statement was given prominence over any other financial statements. Stock price movements were driven largely by growth in the bottom line released by companies. See exhibit 2 for a sample income statement. 

Exhibit 2

XYZ Company

Income Statement for the Fiscal Year  December 31, 2003


Saudi Riyals

Net Sales


Cost of Sales


Gross Profit




Operating Expenses


Selling and Admin. Expenses




Rent Payment




Repairs and Maintenance


Total Operating Expenses




Operating Profits




Other income and expense:


Interest and Dividend Income


Interest Expense


Pretax Income from Continuing Operations


Income from Discontinued Operations


Extraordinary Items


Income before tax & zakat


Income tax/Zakat


Net Income





Net Sales/Revenue is the total revenue generated by the business less any allowances, discounts and returns. This is a key number in the financial statements and is a base for many calculations and analysis. Since sales are an indicator of success in business, the trend of this figure is an indicator of performance. This figure also shows marketing capability of selling the product.  

Cost of Goods Sold or cost of sales is one of the largest expenses deducted from the revenue. The manufacturing cost of the goods that were sold is designated as cost of sales. As this figure is significant it attracts the attention of management and analysts. It has to be noted that the magnitude of the cost of sales figure may vary from industry-to-industry.    

Gross Profit is arrived by subtracting cost of sales and direct costs from net sales revenue for the period reported. This figure is the first profitability measure relating to operations. Gross profit as a percentage of sales is a well accepted primary profit margin. Gross profit is also an industry specific barometer which is influenced by the product and nature of the industry.    

Expenses are the expenses incurred in the course of operation during the reporting period accounted on an accrual basis. This constitutes selling and distribution, administrative expenses, and depreciation and amortization. Details are given depending on the format of presentation. 

Income from Main Operations is a key indicator of overall operational performance of a business. This figure is arrived at after deducting operating expenses from gross profit. Since this figure excludes non-operational items and taxation, it has unique importance. The operational earnings power is revealed by this figure.

Other Revenues and Expenses are of non-operational nature and all items are not recurring. This comprises interest income/expense, dividend revenue, rental revenue and gain/loss from fixed assets disposals etc.     

Income from Continuing Operations refers to the earnings generated from ongoing business. 

Discontinued Operations. Results of discontinued operations are indicated below earnings before taxation. Details of loss or profit of disposal are disclosed along with results of discontinued operations

Income/(Loss) before Extraordinary Items

Extraordinary Items are shown separately below other revenues and expenses. These items are significantly different from usual business activities and expected not to recur often.

 Income/(Loss) before Taxation/Zakat is the profit recognized before deducting income tax/zakat.

Income Tax/Zakat tax expense for the taxable profit earned.

Net income/(Loss) for the year is the overall profit figure of a company after considering all revenues and expenses that have been incurred during the reporting period.