In contrast with the balance sheet that reflects the situation of the company at a fixed point in time, an income statement reflects the company's activity over a period of time. The income statement presents the company's accounting revenues and expenses. A later section will discuss the difference between revenues and expenses and cash movements. The purpose of this statement is to present a summary of the company's activities over this period of time.

The principle guiding the reflection of revenues is that revenues are recognized in the period in which the transaction was made, when uncertainty with respect to its possible closing and to the payment therefore has been resolved. In other words, the transaction may be recorded in a different period from that in which payment therefore will be received. For instance, Speed will record the revenue from the equipment it sold when it closed the sale transaction, although the payment may actually be received later on.

Another important principle is the matching of revenues and expenses. According to this guiding principle, expenses incurred in the production of revenues from products and services are recorded in the same period as the revenues from the sale of such services or products. Thus, Speed will record the cost of the tractor as an expense in the above example only when it records the revenue from the sale of the equipment.

The expenses recorded in the statements reflect all the costs involved in deriving the company's revenues. Expenses are reported under various items in different parts of the statement and include, among others, the cost of materials, labor, marketing, advertising, research and development, and various administrative expenses.

An income statement comprises various items, including the following:

• Revenues— Usually, the first line of an income statement reflects the company's revenues. Such revenues may be recorded as gross revenues, in which case the expenses incurred in their production appear in the line "cost of goods sold"; conversely, the company can present the results on a net basis, in which case the first line will be calculated after deducting various costs relating to the sold goods. Amazon (the world's largest online bookstore), for instance, reports the entire turnover of goods sold by it, and records the cost of the books as an expense. eBay (the world's largest auction site) on the other hand, records as revenue only the commissions it receives on sales made through its site. The difference results from the fact that a company's revenue is tied to the transfer of principal risks and returns on the asset. In eBay's case, the company is not exposed to any risk resulting from the maintenance of inventories, and does not bear various risks of payment transfers and shipments. Consequently, it does not own the sold goods at any stage of the transaction. Amazon, on the other hand, bears the risk involved in the stocking of the goods it sells (including, in many cases, the maintenance of inventories), and therefore recognizes the sale and cost of the goods.

  In many areas involving brokerage and production, lengthy, numerous, and deep discussions are held with respect to the nature of transactions, since these companies often sell products they do not stock. In such cases, a comprehensive examination is required in order to determine who bears the risk of stocking goods during the course of the transactions. In the aftermath of the collapse of the energy trading company Enron and the telecommunications company Global Crossing, issues pertaining to net versus gross recording of revenue are in the center of the public discussion. While there is typically no impact on cash flows from the transactions at different points in time, market participants tend to value firms based on revenue multiples, and hence these definitions become acute.

• Cost of Goods Sold— As mentioned above, costs of goods sold reflects the costs incurred in producing the service or product recorded as a revenue. The components of this cost vary from one company to another in accordance with the nature of the company. In retail companies, for instance, this cost is composed mainly of the cost of the goods themselves, whereas in software companies, the cost of goods sold is composed primarily of the employment costs directly related to the sale. The cost of goods sold will usually also include various components of depreciation, the value of which is loaded onto the price of the sold equipment or service.

• Gross Profits— Gross profits are revenues minus the cost of goods sold. The gross profits and their percentage of the revenues are two of the main parameters for estimating a company's performance. Investors often regard changes in the rates of gross profitability as an indicator of changes in the company's future prospects.

  Profit margins vary dramatically from one industry or market to another. The pharmaceutical industry, for instance, is characterized by a gross profit margin of up to 90%, whereas many retail chains are characterized by gross profit margins of below 25%.

• Operating Profit— The company's operating profit is calculated by deducting depreciation and amortization, general and administrative expenses, research and development expenses, and marketing expenses from the gross profits. Operating profit is an indicator of the company's profit that is disassociated from the company's capital structure. In other words, this profit disregards the company's financing expenses. The assumption underlying the examination of operating profit margins is that the company's capital structure is a variable that depends on a mere managerial decision, whereas the focus on the company's basic data should be made without regard for the company's capital structure considerations.

• EBIT—Earnings Before Interest and Taxes— EBIT is calculated by adding additional items to the operating profit, such as the sale of assets outside the company's ordinary operating activities.

• Net Income— Net income is reached by deducting financing costs, taxes, and irregular items from EBIT. The net income is added to the shareholders' equity after deducting any dividends distributed to the shareholders.

The table below p resents an example of an income statement. The company's revenues amounted to $1 million, and the cost of goods sold was $600,000. Consequently, the gross profit was $400,000. The company's other operating expenses were the salaries of research and development employees ($100,000), marketing and sales ($150,000), general and administrative expenses ($25,000), and depreciation ($50,000). The company's operating profit was therefore $75,000, and after deducting financing expenses of $20,000 and paying tax at the rate of 20%, the company's net income was $44. After distributing a $5,000 dividend to the shareholders, the company's retained earnings increased by $39,000.