What is the income statement?
First and foremost, the Income Statement shows if your business is making a profit over a specific period of time. It includes details on the sales or revenue earned, the cost to produce those sales, and then other operating expenses incurred to run the business. There are generally income and/or expense items that do not fit nicely somewhere else and these are collected in a section called “other”. All of the income and expense items are ultimately combined together and a net total for the period is set forth at the bottom of the statement. Literally, the “bottom line”. This is the first statement that bankers, investors, and potential purchasers want to look at. It is the initial source information for your tax return. The amounts included in the income statement are reset to zero at the end of each year.
Structure
sales
The income statement is arranged from the top down starting with sales or revenue accounts. This section will include total sales followed by deductions from sales. Think discounts and returns. Total sales are referred to as gross sales. The amount after returns and allowances is considered net sales.
Cost of Sales
After the sales section is the cost of sales or cost of goods section. This section contains the cost to produce or acquire the product or service that is sold. It may include the cost of items purchased that are resold, or may be the material, labor and overhead used to create the product that was sold. Sales less cost of sales is equal to net revenue. Service businesses may not have a cost of sales section, keeping all employee and other costs together in the operating expense section that follows.
Operating Expenses
Next section contains the operating expenses which are all of the other expenses used to run the business. Administrative employee expenses, rent, utilities, maintenance, marketing, etc. There may be a final section called “other” containing, items not necessarily related to the operation of the business. Interest income or expense and income taxes are frequent.
Depreciation deserves special mention. When larger, capital items are purchased they are considered assets and located on the balance sheet. This includes machinery, equipment, furniture, and other items meant to be used for a period longer than one year. An allowance or charge for the wear and tear on the item is included in operating expenses over time.
Format
The most common format of the income statement includes columns for the current month and the current year to date. Comparative columns for the same numbers from the prior year and columns indicating the change in dollar and/or percent amounts between the years are usually included.
The income statement includes as much account level detail information as is useful for the business and the reader. Detail level accounts are created to provide the information necessary to review and monitor the operation of the company. The accounting department and Controller will want to review the most detail, the board generally gets a more concise presentation along with explanations for differences.
Using the income statement
The income statement shows the results of the entity over a period of time. The first look is to see how the entity performed over that period. What is the bottom line? Then start comparing the current period information to various expectations. This is where the value of the income statement comes from. In general you will want to compare the information statement to what you expected to happen. Did this year exceed last year, did the various amounts presented equal or exceed what was expected? Expectations can be informal or detailed as a budget or forecast. When expectations deviate from actual the individual accounts and categories need reviewed to find out where the difference lies. Those differences from expectations are points to manage.
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