What is the purpose of the income statement?

One of the indicators of a company’s profitability, a key financial statement in accounting, which presents the revenues, expenses, and financial result of a specific period – typically a financial year. Its purpose is to provide a detailed picture of the company’s income-generating capacity, efficiency, and the economic result of its operations.

The Hungarian Accounting Act (Act C of 2000) prescribes the preparation of the income statement, which is one of the key components of the financial statements.

Determining the Result

The result of the financial year is determined in the income statement. This statement presents the derivation of the after-tax profit and the factors that influence its formation.

The after-tax profit must be determined based on the operating (business) result and the financial operations result (together: profit before tax), reduced by the amount of the payable tax, and – if necessary – adjusted by the deferred tax difference (Accounting Act §70).

How can the operating profit be determined?

a) Total cost method: as the difference between net sales revenue, own performance value, other revenues, and material, personnel, and other expenses, as well as depreciation.
b) Cost of sales method: net sales revenue is reduced by direct and indirect costs, then the difference of other revenues and expenses is added.

Both methods lead to the same result, the difference lies only in the applied breakdown and data structure. The total cost method is typically chosen by companies that do not require detailed cost-of-sales data, while the cost of sales method is mostly used by manufacturing and trading companies. Annex 2 of the Accounting Act contains the detailed structure of the total cost method, while Annex 3 contains that of the cost of sales method.

The Role of the Income Statement in Business Decision-Making

The income statement is not only a legal requirement but also a valuable analytical tool:

• Profitability evaluation – shows the extent to which revenues exceed expenses.
• Cost efficiency analysis – analysis of individual cost types or functional cost groups helps to implement efficiency-enhancing measures.
• Tracking trends – comparing several periods reveals trends in revenues and expenses.

Creditor and investor information – for banks and investors, it is one of the most important indicators of the company’s financial performance.
Companies often use the data of the income statement to calculate financial indicators (e.g. profit margin, EBITDA, ROE, ROA), which provide further insight into operational efficiency.

Rules and Practice of Preparing the Income Statement

The income statement can be compiled from cost, expense, and revenue account data.
Only one line, the “after-tax profit”, is carried over to the balance sheet. Essentially, the after-tax profit can be determined in double-entry bookkeeping as the difference of the combined balances of account classes 5–8 and 9, or from another approach, it appears as the difference in balances of asset and liability accounts.

In summary, the income statement is one of the most important indicators of a company’s operational performance. It not only serves the purpose of complying with legal requirements but also provides information that is essential for management, owners, investors, and creditors.
It allows for an objective evaluation of the company’s profitability and efficiency and supports well-founded decisions about future operations.

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