Remember:

• Sales - Direct Costs = Gross Profit

• Gross Profit - Indirect Costs = Net Profit

Gross Profit and Net Profit are the most important figures in an income statement. The other elements are Sales, Direct Costs, and Indirect Costs. Comparing Direct Costs to Indirect Costs helps clarify the Sales figure.

Large companies like Reliance have multiple income sources, such as oil production, refining, marketing, and petrochemicals. Each segment's performance is shown separately in their income statement, making the Sales figure appear complex. However, this separation is necessary to understand how each segment contributes to the company's income. The company must also disclose information based on geographical or other factors, making the statement more detailed and potentially complex.

Cost and Expenses 

There are two types of expenses:

1. Direct Expenses: These are directly related to sales and are proportional to the sales volume. Examples include the cost of producing or purchasing the goods sold. These costs are also known as "Cost of Sales" or "Cost of Goods Sold".

2. Indirect Expenses: These are operating expenses not directly related to sales, such as employee salaries, advertising, rent, and other overheads.

Both direct and indirect expenses are deducted from revenue to calculate gross profit. Gross profit is then reduced by indirect expenses to arrive at net profit. Note that both direct and indirect expenses may not necessarily represent actual cash outflows.

Cash and Non-Cash Expenses

To fully understand the profit and loss statement, it's important to know the difference between cash and non-cash expenses.

• Cash Expenses: These are expenses where cash is paid immediately, such as salaries, rent, and utility bills.

• Non-Cash Expenses: These are expenses that don't involve immediate cash outflow, such as depreciation (the decrease in value of assets like machinery over time).

Both cash and non-cash expenses are shown as deductions from gross profit in the income statement. Accountants consider any decrease in assets or economic benefits as expenses, regardless of whether cash is involved. For example, depreciation is a non-cash expense that reduces the value of an asset over time but doesn't require immediate cash payment.

Expenses - Good or Bad?

When an income statement shows too many expenses, it's a warning sign that profitability is being affected. In such cases, management must identify areas to cut costs and improve profitability. Any steps taken to reduce expenses are considered positive.

Expenses can also be classified as fixed or variable, depending on whether they can be controlled or not. While direct and indirect expenses are based on their relationship with sales, fixed and variable expenses are based on their nature. Fixed expenses remain the same even if sales increase or decrease, whereas variable expenses change with sales.

The income statement may seem complicated at first due to the detailed information provided for clarity and transparency. Accountants aim to provide maximum detail to help the public and investors understand a company's performance and make informed decisions.