How to Read An Income Statement For Online Business?
The income statement of a business represents the revenues, expenses, profit or loss, or other comprehensive income. An e-commerce business may earn revenues in ways different from other businesses like manufacturing. These may include merchandising activities, membership, subscription, advertising services, or other services like web hosting, content selling, etc.
Likewise, an e-commerce business’s expenses may vary relative to any other business. For instance, product and content costs, payment processing and related transaction costs, picking, packaging, preparing orders for shipment, etc.
Thus, an e-commerce business needs to know the outcome of all the operations it carries out during a particular period. Accordingly, it needs to prepare a flow report called an income statement.
A flow report, such as an income statement, presents the flows in a business resulting from your business operations. In an e-commerce business, such operations may include purchasing or producing inventories, selling goods online, and collecting cash from customers.
Thus, an Income Statement of a business reports its financial performance during a specific period. This means an e-commerce business may improve performance by increasing its operating income. It can increase the operating income by increasing the sale of products and services or efficiently managing its operating costs.
In this article, we will talk about an income statement and how to analyze the income statement for an e-commerce business.
What Is An Income Statement?
An Income statement is another basic financial statement that a business must prepare to represent all the income and expense items, including other comprehensive income. Such expenses and incomes are recognized in a single statement of profit and loss when they are incurred and earned.
In other words, a traditional income statement of a business represents its earning activities. Further, it describes an entity’s outcome of all revenue-generating activities. The income statement is also known as the profit and loss statement.
This statement comprises two segments. One of the segments represents the inflow of funds resulting from selling goods and services to consumers. The inflows refer to the assets that an entity creates by generating revenues. Such assets may include cash or accounts receivable.
The other segment of the income and expense statement represents the outflow of resources. These resources are utilized to generate sales. Such outflows are called expenses. The net excess of all the revenues over expenses represents the net income of a business during an accounting period. At the same time, the excess of all the expenses over revenues represents the net loss of a business.
Income and expenses are presented in different ways in the profit and loss statement. This is to provide information that is relevant for economic decision-making.
Accordingly, income and expense items arising in the normal course of business are shown separately as operating incomes and operating expenses. For instance, the income sale of goods or services is operating income. And the cost of fulfillment, sales, marketing, and technology are operating expenses of an e-commerce business.
Likewise, incomes and expenses other than the normal course of business are shown separately as non-operating and non-operating incomes. For instance, interest income is non-operating and in,terest expense is non-operating.
Preparing Income Statement for an E-Commerce Business
An Income Statement is a financial statement that summarizes company revenue and expenses. The income statement should be prepared along with the balance sheet and cash flow statement to know the financial performance of a business.
The following is the list of income and expense items a business must represent in a simple income statement for a given accounting period. Let’s understand this with the help of the Amazon Income Statement For 2020.
Revenue in the income statement refers to a business’s top line or sales. Sales refer to the invoice value of goods and services delivered to customers during an accounting period. It represents the total amount of income earned from the sales of products or services.
In other words, the value of invoices the business issues is not the same as the cash received. For instance, when you raise a customer invoice, it showcases in the income statement that work has been done. But, such an entry does not represent the customer’s cash receipt.
Note that the Gross Sales of a business do not include any taxes such as sales tax and excise tax or freight and postage. Typically, sales represent the first and usually the largest line of the income statement.
The Amazon Income Statement for 2020 represents that it earns revenue through its online stores, sells content like music, movies, etc., and sells technology services to developers. Besides this, it also provides services like advertising to sellers, vendors, publishers, authors, and others through its sponsored advertisement programs.
Amazon generates revenue from retail sales, third-party seller services, subscription services, AWS, and other services.
2. Cost Of Sales or Cost of Goods Sold
The cost of goods sold represents the costs directly incurred to produce or purchase goods or render services to be sold to the ultimate consumers.
The Cost of Goods Sold in the income statement of a business represents the cost directly associated with manufacturing products. Such costs may include materials and contract labor, packaging, etc. In certain businesses, the Cost of Goods Sold can also represent the cost of the goods a business purchased for reselling in the market.
Note that the cost of sales is typically variable. This means that such a cost fluctuates with the changes in the sales volume. Accordingly, an increase in sales would lead to an increased cost of sales. Likewise, a decrease in sales leads to a decreased cost of sales.
The Amazon Income Statement for 2020 represented the Cost of Sales, including the purchase price of consumer products, inbound and outbound shipping costs, digital media costs, etc.
3. Operating Expenses
The Operating Expenses in Income Statement refer to the costs that an entity incurs to run its business. Such expenses may include office rent, salaries, advertising, warehousing, telephone, etc.
In addition to these costs, the operating expenses of a business also include depreciation. Depreciation represents the wear and tear of assets like machinery, vehicles, office equipment, and furniture over time. Depreciation is an expense that spreads the cost of an asset over its useful life.
Unlike the cost of sales, the operating expenses of a business are not the ones that can be directly linked to the production of goods or rendering the services being sold.
The Amazon Income Statement for 2020 represented the following operating expenses:
- Fulfillment costs incurred in fulfillment stores, physical stores, and customer service centers. Such costs also included buying, receiving, inspecting, and warehousing inventories. Besides this, it also includes costs of picking, packaging, payment processing, etc.
- Technology and contempt costs like payroll and related expenses for employees involved in researching and developing new and existing products. It also includes costs for maintaining online stores and infrastructure like servers, networking equipment, depreciation for data centers, etc.
- Marketing costs like advertising and payroll for employees engaged in marketing activities. It also includes sales commissions related to AWS and commissions to third parties.
- General and Administrative expenses like payroll, depreciation, rent, professional fees, and litigation costs.
- Stock-based compensation
- Other operating expenses
4. Finance Costs
These costs include the interest expense. The interest expense refers to the income allocated towards the funds a business borrows. Such funds are typically borrowed from banks.
The interest expense in the income statement of Amazon Inc included interest on notes payable paid semi-annually. Besides this, the interest expense also includes interest at LIBOR for the secured revolving credit facility that the company secured from a lender. Further, the company also has a current portion of long-term debt carrying interest.
The taxes in the income statement represent the corporation tax and other taxes. For instance, the income statement of Amazon Inc as of December 31, 2020, showcased income taxes, including federal taxes and foreign income taxes. Further, the tax balance also includes Deferred Income Tax balances.
6. Net Profit After Taxes
The Net Profit in the income statement represents the difference between total revenues or incomes earned and total expenses incurred by a business entity during an accounting period.
It tells all the stakeholders how much income the business earned or lost during the accounting period. Note that the gross profit determines how profitable a business is in selling its products or services. At the same time, the operating profit demonstrates how efficiently the management controls the business’s production and operating costs.
For instance, the operating income of Amazon Inc represents the operating income from North America, AWS, and international operations. The operating income of North America and international operations increased relative to the previous year due to increased unit sales. These sales included sales by third-party sellers and advertising sales.
Likewise, the operating income from AWS operations increased relative to the previous year. This was on account of the increased customer usage and cost structure productivity.
Analyzing an Income Statement for E-Commerce Business
The following section represents the Profit and Loss Statement or Income Statement Template for an e-commerce business.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)
|Net product sales||141,915||160,408||215,915|
|Net service sales||90,972||120,114||170,149|
|Total net sales||232,887||280,522||386,064|
|Cost of sales||139,156||165,536||233,307|
|Technology and content||28,837||35,931||42,740|
|General and administrative||4,336||5,203||6,668|
|Other operating expenses (income), net||296||201||(75)|
|Total operating expenses||220,466||265,981||363,165|
|Other income (expense), net||(183)||203||2,371|
|Total non-operating income (expense)||(1,160)||(565)||1,279|
|Income before income taxes||11,261||13,976||24,178|
|Provision for income taxes||(1,197)||(2,374)||(2,863)|
|Equity-method investment activity, net of tax||9||(14)||16|
|Basic earnings per share||20.68||23.46||42.64|
|Diluted earnings per share||20.14||23.01||41.83|
|Weighted-average shares used in the computation of earnings per share:|
The revenues of a business for the current year compared to the previous showcases growth in sales if there is an increase. However, a decrease in revenues for the current year relative to the previous year shows a decline in sales.
Likewise, the operating income showcases the efficiency of your business. In other words, it demonstrates how well a business manages its costs and increases sales.
Similarly, the business expenses for the current accounting period relative to the previous period showcase how the total expenses have changed.
Thus, to analyze the income statement, a business can undertake any of the following activities:
1. Comparative Income Statements
The comparative income statement showcases a business entity’s profitability and financial position for different periods in a comparative format.
Such a comparison of financial data gives insights into the financial performance of a business over two or more periods.
Note that the financial data represented in the income statements for different periods can be compared only when the same accounting principles are used to prepare the income statements. If the same accounting principles are not used to prepare the income statements for different periods, then it must be mentioned in the footnotes.
The comparative financial data showcases the trend as well as the direction of the financial position and operating results of a business. Since the data of different accounting periods is compared horizontally in the income statement, this analysis is also known as ‘horizontal.
The following is the comparative income statement of Amazon Inc to help you understand the format of the comparative income statement.
Comparative Income Statement Of Amazon Inc
|Cost of Revenue||$233,307,000||$165,536,000||$139,156,000||$111,934,000|
|Research and Development||—||—||—||—|
|Sales, General and Admin.||$129,858,000||$100,445,000||$81,310,000||$61,826,000|
|Other Operating Items||—||—||—||—|
|Add’l income/expense items||$2,926,000||$1,035,000||$257,000||$548,000|
|Earnings Before Interest and Tax||$25,825,000||$15,576,000||$12,678,000||$4,654,000|
|Earnings Before Tax||$24,178,000||$13,976,000||$11,261,000||$3,806,000|
|Equity Earnings/Loss Unconsolidated Subsidiary||—||—||—||—|
|Net Income-Cont. Operations||$21,331,000||$11,588,000||$10,073,000||$3,033,000|
|Net Income Applicable to Common Shareholders||$21,331,000||$11,588,000||$10,073,000||$3,033,000|
2. Common Size Statements
A business’s Common Size Income Statements indicate the relationship of different income or expense items with a common item like sales. Further, the relationship of each income or expense item with a common item is represented as a percentage of that common item.
The percentages thus calculated for the current year can be easily compared with the percentages of the corresponding items in the previous year.
The percentages of income or expense items for a given period can be compared with the corresponding percentage items for a different firm for the same period. Such a comparison is possible as the income or expense amounts are reduced to a common base.
This means the financial analysts of a business can compare the operating and financing attributes of two companies of different sizes in the same industry.
Thus, the common size income statements help the financial managers perform intra-firm comparisons over different years and inter-firm comparisons for the same year or several years. Since the percentages are calculated vertically, this is called ‘Vertical analysis.’
The following is the common-size income statement of Amazon Inc to help you understand the format of the common-size income statement.
|Particulars||Q3 2019||Q4 2019||Q1 2020||Q2 2020||Q3 2020||Q4 2020||YOU %|
|Online stores — Y/Y growth, excluding F/X||22%||15%||25%||49%||37%||43%|
|Physical stores — Y/Y growth, excluding F/X||(1)%||(1)%||8%||(13)%||(10)%||(7)%|
|Third-party seller services — Y/Y growth, excluding F/X||28%||31%||31%||53%||53%||54%|
|Subscription services — Y/Y growth, excluding F/X||35%||32%||29%||30%||32%||34%|
|AWS — Y/Y growth, excluding F/X||35%||34%||33%||29%||29%||28%|
|Other — Y/Y growth, excluding F/X||45%||41%||44%||41%||49%||64%|
|Cost of sales||39||43||41||76||112%|
|Technology and content||40%|
|General & administrative||20%|
|Total stock-based compensation expense||39%|
|WW shipping costs — Y/Y growth||67%|
|Employees (full-time and part-time; excludes contractors & temporary personnel) — Y/Y growth|
3. Ratio Analysis
Ration analysis is another financial tool that helps analysts to analyze the financial data represented in the income statement of a business. It describes the significant relationship between various items of a balance sheet and a statement of profit and loss of a business.
In other words, the accounting ratios measure the comparative importance of the individual items of the income statement and balance sheet. Such an analysis helps a business to assess its profitability, solvency, and efficiency.
For instance, a business can calculate profitability ratios. These ratios help determine a business’s ability to generate profits as against Sales, Operating Costs, Assets, and Shareholder’s Equity. Such ratios reveal how well a company uses its assets to generate profitability and create shareholder value.
The following are some important profitability margin ratios a business can determine.
(a) Gross Profit Margin
Gross Profit Margin measures the Gross Profit against the sales revenue of a business. This margin demonstrates a business’s earnings after considering the costs incurred to produce goods and services.
The higher a business’s Gross Profit Margin ratio, the higher ts efficiency in carrying out its operations. This means higher gross profits for the business to cover its operating expenses, fixed expenses, dividends, and depreciation. Also, high gross profit results in increased net earnings for the business.
Likewise, a low Gross Profit margin indicates a higher cost of goods sold for the business. The higher Cost of Goods Sold (COGS) can be due to lower sales, lower selling prices, lower COGS, market competition, etc.
The formula for Gross Profit Margin is:
Gross Profit Margin = Gross Profit/Revenue
(b) Operating Profit Margin
The operating Profit Margin is calculated by determining the Operating profit. Operating Profit is determined by subtracting operating costs from the business’s gross profit. Then Operating Profit Margin is calculated by dividing operating profit by Net Sales.
If the operating profit margin increases faster than the Gross Profit Margin, the company’s management efficiently controls the operating costs. Thus revealing the quality of the management’s decision-making.
On the other hand, a lower operating profit margin reveals the inability of the management to regulate its operating costs.
Following is the formula for Operating Profit Margin:
Operating Profit Margin = Operating Profit/Revenue
(c) Pre-Tax Margin
Pre-Tax Profit Margin must be calculated to determine Pre-Tax Income or Earning Before Tax (EBT). EBT refers to the operating profit less interest. Thus, Pre-Tax Profit Margin is the ratio of Pre-Tax Income to Revenue.
The pre-Tax Profit Margin ratio showcases the impact of non-operating income, expenses, and interest on the business profitability. A high Pre-Tax Profit Margin ratio could result from increasing the non-operating income of the business.
Following is the formula for the Pre-Tax Margin Ratio:
Pre-Tax margin = Earnings Before Tax But After Interest (EBT)/Revenue
(d) Net Profit Margin
Net Profit Margin is the percentage of profit a business generates from its revenues. This ratio showcases the net profit amount a business can generate for every unit of increase in revenue. Thus, the Net Profit Margin ratio links revenue from operations to the net profit of a business. Note that net profit is calculated after considering all the operating and non-operating incomes and expenses of the business.
Following is the formula for Net Profit Margin:
Net Profit Margin = Net Income/Revenue
The following table showcases the liquidity and solvency ratios of Amazon Inc that will help analyze its financial performance over the years.
4. Trend Analysis
This is another technique e-commerce businesses can use to study the operational results and financial position over several years. For instance, they can use previous years’ data and analyze the trends in the different income statements and balance sheet items by calculating percentage changes.
The trend percentage is the relationship in which each item of different years bears the same item in the base year. The trend analysis is important as it gives a long-run view of an e-commerce business’ key financials. Plus, it may also point towards the basic changes like the business.
Thus, a business can analyze whether a ratio is falling, rising, or remaining relatively constant by looking at a trend in a particular ratio. From such an observation, the management can detect problems and opportunities.
Recognition of Income
Like any other business, an e-commerce business needs to be recognized in the income statement. It is done when an increase in future economic benefits related to an increase in an asset or a decrease in liability has arisen. Further, it should be possible for the business to measure income reliably. This means a business must recognize income simultaneously with recognizing asset increases or liability decreases.
For example, the net increase in assets arising from a sale of goods or services or the decrease in liabilities arising from waiving a debt payable.
Note that to recognize income, the revenue should be earned. Further, such income can be
measured reliably and has a sufficient degree of certainty.
Recognition of Expense
An e-commerce business, like any other business, must recognize expenses in the income statement. This must be done when a decrease in future economic benefits related to a decrease in an asset or an increase in liability has arisen. Further, the business can measure such expenses reliably.
Thus, an e-commerce business must recognize expenses simultaneously with recognizing an increase in liabilities or a decrease in assets— or example, the accrual of employees’ salaries or the depreciation of plant and machinery.
Note that many expenses are recognized in the profit and loss statement based on a direct connection between the costs incurred and the earning of specific income items.
Such a process is called the matching of costs with revenues. t involves simultaneous or combined recognition of revenues and expenses resulting directly or jointly from the same transactions or other events.
For example, the expenses forming a part of the cost of goods sold are recognized simultaneously as the income derived from the sale.
Then, there are cases when the economic benefits from expenses are expected to arise over several accounting periods. urther, the association of expenses with income can only be broadly or indirectly determined. n such scenarios, the income statement must recognize the expenses based on systematic and rational allocation procedures.
This is often necessary for recognizing expenses associated with utilizing assets like plant and machinery, goodwill, patents, and trademarks. He expense in such cases is called depreciation or amortization.
Remember, such allocation procedures recognize expenses when the associated economic benefits are consumed or expire in the accounting periods.