The income statement is an essential element of a company's annual financial statements, showing income and expenses over a specific period - usually a financial year. Its main purpose is to measure the success or failure of a company by determining the profit made or loss incurred.
The income statement structures the financial activities of a company and shows:
By comparing income and expenses, the company's net profit is calculated, i.e. the profit if income exceeds expenses, or the loss if expenses are higher than income. The income statement thus provides important information for Corporate Management, investors and other stakeholders to assess the financial situation and performance of the company.
The profit and loss account (P&L) is divided into various items that systematically record a company's income and expenses. Here is a typical P&L structure:
This structured layout helps to present the financial performance of a company clearly and transparently and provides a sound basis for business management decisions.
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Back to the Financial DictionaryThe table with the differences between the balance sheet, profit and loss account (P&L) and Cash Method of Accounting (Cash Method of Accounting) shows the different purposes, contents, preparation dates, areas of application and results of these important business management instruments in comparison. Here is the table with the differences between the balance sheet, income statement and Cash Method of Accounting:
| Criterion | Balance sheet | Income statement | Cash Method of Accounting |
|---|---|---|---|
| Purpose | Presentation of the assets and liabilities of a company | Determination of the annual result (profit or loss) | Determination of the taxable profit for smaller companies |
| Contents | Assets (assets) and liabilities (debts and equity) | Income and expenses | Income and expenses (simplified form) |
| Date of preparation | At the end of a financial year | For the entire accounting period (usually financial year) | For the entire accounting period (usually financial year) |
| Legal form/application | Mandatory for corporations and larger companies | Mandatory for all companies required to keep accounts | For freelancers, small traders and sole traders not required to keep accounts |
| Result | Net assets: Comparison of assets and liabilities | Income statement: Difference between income and expenses | Taxable profit: Difference between income and expenses |
The obligation to prepare a profit and loss account (P&L) depends on the legal form and size of the company, as well as the legal requirements in the respective country. Here are the main categories of companies that must prepare a P&L:
Companies must prepare a P&L if they are obliged to keep accounts in accordance with Section 141 of the German Fiscal Code (AO), in particular if they:
This table provides an overview of which types of companies are obliged to prepare a P&L and under what conditions.
| Company Type | Obligation to prepare a P&L? |
|---|---|
| GmbH | Yes, according to HGB |
| AG | Yes, according to HGB |
| OHG & KG | Yes, if required to prepare a balance sheet |
| Sole proprietorship | Yes, if entered in the commercial register or turnover/profit limits exceeded |
| Freelancer | No, except for voluntary double-entry bookkeeping |
| Small business owners | No, can use Cash Method of Accounting |
The obligation to prepare a P&L depends on the legal form of the company, the turnover and profits generated and the entry in the commercial register. Corporations are always obliged to prepare a P&L, while smaller companies and freelancers can use a Cash Method of Accounting under certain conditions.
Important terms for the P&L
| Term | Meaning |
|---|---|
| Revenue | Income from the sale of products or services |
| Changes in inventories | Changes in inventories of finished goods and work in progress |
| Other own work capitalized | Internally generated and used services within the company |
| Other operating income | Income that does not originate from the core business (e.g. rental income) |
| Cost of materials | Cost of raw materials, consumables and supplies as well as purchased goods |
| Personnel expenses | Expenses for wages, salaries and social security contributions |
| Depreciation and amortization | Impairment of fixed assets |
| Other operating expenses | Operating costs such as rent, advertising, insurance, etc. |
| Operating result | Result from ordinary activities |
| Financial income | Income from financial transactions, including interest and dividends |
| Financial expenses | Expenses from financial transactions, including interest |
| Result from ordinary activities | Sum of operating and financial result |
| Extraordinary income | Non-recurring and unusual transactions |
| Extraordinary expenses | Expenses from non-recurring and unusual transactions |
| Earnings before taxes | Earnings before taxes |
| Taxes | Expenses for income and other taxes |
| Net profit/loss for the year | Final result of the income statement, the final profit or loss for the financial year |
This table summarizes the most important terms and their meanings in the income statement.
The income statement calculates a company's net profit or loss for the year by comparing income and expenses. The following are the basic formulas for calculating the result.
Let's assume we have the following figures:
The complete basic formula is as follows:
The formula can be broken down into its individual components to make it clearer and easier to understand:
All amounts of money that occur in the company are included here.
All financial amounts are offset in this section.
All business activities, operating and financial results, are offset here.
The extraordinary amounts are offset in this section.
The two previous results are now offset before taxes come into play.
Finally, taxes are deducted, and the final result is obtained.
In this example, the net profit for the year amounts to € 77,000. This structure and calculation show how the various types of income and expenses contribute to the determination of a company's financial result.
The net and gross principles are two different methods of presenting income and expenses in the income statement. Both principles have their specific applications and influence the transparency and comprehensibility of a company's financial information.
This table summarizes the main differences and features of the two principles.
| Criterion | Net Principle | Gross Principle |
|---|---|---|
| Presentation | Only balance of income and expenses | Complete separation of income and expenses |
| Transparency | Lower | Higher |
| Comprehensibility | More difficult | Easier |
| Clarity | Higher | Lower |
| Application | Specific situations, smaller companies | Larger and capital market-oriented companies |
In practice, the gross principle is often used, especially for larger and capital market-oriented companies, as it offers greater transparency and depth of detail. The net principle can be used in specific situations or for smaller companies in order to simplify the presentation.
The choice between the net and gross principle depends on the requirements for transparency, comprehensibility and clarity of financial reporting. The gross principle offers a more detailed and transparent presentation, while the net principle enables a simplified and clearer presentation. Companies should choose the method that best suits their reporting requirements and legal requirements.
The P&L can be presented in various forms, which differ mainly in their structure and level of detail. Here are the most important forms of the profit and loss account:
The following diagram shows the forms and methods of the P&L.
These different forms of P&L allow companies to present their financial results in a flexible way that is adapted to their specific needs.
The P&L can be presented in two different forms: the account form and the scale form. Both forms have their specific characteristics and possible uses. In practice, the scaled form of the income statement is more common, as it enables a detailed and transparent presentation of a company's earnings situation. The account form has a simpler structure but is less informative. Both forms have their raison d'être and can be used depending on the company's requirements and preferences.
The scale form shows the income and expenses in relation to each other and calculates the profit or loss step by step. Both the nature of expense method and the cost of sales method can be presented in the scale form.
Examples of this follow in the explanation of the methods.
The account form is similar to a T-account, where income and expenses are compared. This form is rarely used as it is less detailed.
Example of the account form:
| Income | Expenses |
| Sales Revenue | Personnel Expenses |
| Other Own Work Capitalized | Depreciation |
| Other Operating Income | Other Operating Expenses |
| Financial Income | Extraordinary Expenses |
| Total Income | Total Expenses |
| Profit/Loss |
This table summarizes the main differences and features of the two forms of presentation of the P&L statement.
| Criterion | Scaled Form | Account Form |
|---|---|---|
| Form | Intercompany | T-account-like |
| Presentation | Step-by-step calculation of profit or loss | Comparison of income and expenses |
| Clarity | Very detailed | Less detailed |
| Widespread | Widespread | Less widespread |
| Advantages | Detailed, transparent presentation, clear profit levels | Simple structure, quick comparison |
The P&L statement can be prepared using two different methods: the total cost method and the cost of sales method. Both methods have specific features and classifications. Both methods have their advantages and disadvantages and the choice of method often depends on legal requirements, international accounting standards and the specific needs of the company.
The nature of expense method records all income and expenses for the financial year and breaks them down by cost type.
Example of the total cost method in scale form:
+ Sales revenue
+/- Changes in inventories
+ Other own work capitalized
+ Other operating income
- Cost of materials
- Personnel expenses
- Depreciation and amortization
- Other operating expenses
= Operating result
+ financial income
- Financial expenses
= Result from ordinary activities
+ Extraordinary income
- Extraordinary expenses
= Result before taxes
- Taxes
= Annual Income/Loss
The cost of sales method allocates expenses to the sales generated and classifies them according to functional areas.
Example of the cost of sales method in scale form:
+ Sales revenue
- Cost of sales of the services rendered to generate the sales revenue
= Gross profit from sales
- Selling expenses
- General administrative expenses
+ Other operating income
- Other operating expenses
= Operating result
+ Financial income
- Financial expenses
= Result from ordinary activities
+ Extraordinary income
- Extraordinary expenses
= Result before taxes
- Taxes
= Annual Income/Loss
This table summarizes the main differences and characteristics of the two methods, the total cost method and the cost of sales method, for preparing a P&L statement.
| Criterion | Total Cost Method | Cost of Sales Method |
|---|---|---|
| Breakdown | By cost type | By functional area |
| Transparency of production costs | Detailed breakdown | Focus on distribution costs and administrative costs |
| Application | Widely used in Germany | Widely used in an international context |
| Advantages | Comprehensive presentation of all cost types | Clear allocation of costs to functions |
| Disadvantages | Can be complex and extensive | Less detailed breakdown of production costs |
The operating result in the P&L is the balance of operating income and expenses, which shows how profitable a company's core business is. It shows how successful the company has been in its ordinary business activities, excluding financial results, extraordinary results and taxes.
The P&L Account is neither an asset nor a liability, but a profit and loss account that is closed in equity at the end of the year.
The P&L contains income and expense accounts.
No, the Business Assessment and the P&L statement are not the same thing; the Business Assessment is a short-term, internal evaluation for company management, while the P&L statement is part of the annual financial statements and is required by law.
The annual income/loss from the income statement is included in the balance sheet as part of equity.
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