Income statement or P/L statement is a financial statement that summarizes the revenue, expenses and the profit/loss generated by a business over a period of time. For example, you can write an income statement for a period from 01.04.2022 to 31.03.2023 or from 01.01.2022 to 31.03.2022. Generally, an income statement is prepared for an accounting period

What is an Income Statement?

Revenue: the total earnings of a company summarized during a specific accounting period.
- Sum of gross receipts earned during a specific timeframe. 💰

Understanding Revenue 💰

In accounting, revenue and expense can be recognized through two methods:<ol><li> Accrual method: Income is recognized as and when it is billed, even if cash has not been received yet.</li><li> Cash basis accounting: Income and expenses are recognized when cash is actually received or paid, respectively.</li></ol>In the income statement, the accrual method is followed, which means that revenue and expense are recorded as they are earned and incurred, respectively.

Recognition of Income and Expense

<ul><li>Business Entity Assumption: A business's transactions are kept separate from those of its stakeholders, except for sole proprietors.</li><li>Monetary unit assumption: Transactions in the income statement are not adjusted for inflation.</li></ul>In the income statement, a business's expenses and income are recorded separately from its stakeholders, except in the case of sole proprietors. This helps to accurately track the financial performance of the business.Additionally, the transactions in the income statement are not adjusted for inflation, meaning that they are recorded at their original value

Assumptions in the Income Statement

Cost Principle: Transactions are recorded at their original cost, not market value.
Going Concern Principle: Transactions are recorded as if the business will continue indefinitely.

Assumptions in Income Statement Cont'd...

Any business generates assets that are then sold off to create revenue. As per the matching principle, only the expenses which are related to the realized sales are treated as expenses

Matching of Revenue and Expenses

Generally, there are two types of expenses.Operating expenses : General expenses involved in functioning of a business. Eg: rent, purchase of Raw materials, cost of conversion, marketing costs, salary, electricity expenses etcNon-operating expenses: Expenses involving depreciation, interest on loansetc.

Types of Expenses

Revenue- expenses= Profit earned

Equation Of Income 

Understanding Profit and Loss Statements and Income Statements

Options are derivative contracts which enable the holder to sell the underlying asset at a predetermined price

What are Options?

The holder of an option contract is not mandated to exercise the option. If the market movement is adverse, he or she may stay out of exercising the contract. However, the writer of an option contract must exercise his side of obligation in case the holder exercises the option. Thus, options create one sided obligation.

Why are Options called So

Premium is the upfront amount the writer demands from the holder for writing the options contract

What's a Premium

Strike price is the pre determined price at which the option contract can be exercised.

What is a Strike Price

Date on or before (American option) or date on(European option) which the option can be exercised is called maturity period.

Maturity Period

An underlying asset can be anything from stocks, bonds, interest rate swaps etc.

What is an Underlying Asset?

Call options is an options contract for buying the underlying asset. Put options is an options contract for selling the underlying asset.

What are Call Options and Put Options

Comparison of the option contract with the market movement is called moneyness. It is of three types 1) In the money2)Out of money3) At the money

What is moneyness

In the Money- if the holder of an option can profitably exercise the option, then it is called In the money.Out of Money- if the holder of an option cannot profitably exercise the option, then it is called Out of moneyAt the Money- if there is no profit or loss from exercising the option, then it is called at the money

Definitions of Moneyness 

In the money: if the forward price is lower than strike price
Out of money: if the forward price is higher than strike price

Moneyness of Put Option

<ul><li>It is the movement of the underlying asset in the market. It is measured by taking ln(Spot rate of today/spot rate of day before). Log is taken as the distribution is log normal in nature.</li><li>Upon which we calculate the standard deviation.</li></ul>

What is Volatility

In practise, all option contracts are cash settled. Means there is no delivery of the underlying asset except in case of stocks.The cash value a holder gets upon exercising the option at current spot rate is called intrinsic value

Intrinsic value of Option

For example, an investment bank agrees to write a call option with 100 google stocks at $100.00 per share and the current market price is $120.00. The intrinsic value is $20 per share

Calculating Intrinsic Value of an Option

Time value is the amount that an investor is willing to pay for the possibility that the option will be in-the-money before it expires. It represents the potential future value of the option. It is calculated from standard deviation based on volatility

What is Time Value

Premium=intrinsic value+time value.

Formula For Premium

Put-call parity is a fundamental relationship in european options pricing that states that the price of a put option, the price of a call option, the underlying asset price, and the strike price are all related. The formula for put-call parity is:C + K = P + FC is the price of the call optionK is the strike price of the optionP is the price of the put optionF is the price of the underlying asset

Put Call Parity

Understanding Options

What is a balance sheet?As the name suggests, a balance sheet is a financial statement that provides a snapshot of the overall business position of a Company. A balance sheet can be prepared as on any said date. For example, balance sheet of 31.03.2023 shows the position of the Company as on 31.03.2023

Accounting-Balance Sheet

a) Accountants and finance managers who are tracking the performance of the Companyb) Upper management directly responsible to boardc) Outside potential investorsd) Investors already invested in the Companye)Government, regulators and stock markets

Who needs a balance sheet?

Basically there are three items in a balance sheet. a)Owner's equity or Capitalb)Liabilitiesc)Assets

Items of a balance sheet

Basically, It is the money brought in by the promoter.It includes paid up capital, premium reserves after issuing shares, surplus reserves etc

Owner's Equity

It is the money the Company has borrowed from outside for it's business. It includes all outside short term and long term borrowings

Understanding Profit and Loss Statements and Income Statements

Understanding Options

Accounting 101: Understanding the Basics of Balance Sheets

Ramakrishnan Natarajan