Understanding the Income Statement

Welcome to my regular accounting and finance blog. Today is November 6, 2018.

My blogs are designed to teach basic accounting and financial concepts that everyday people can apply to their financial and business lives. With each blog I will explain an accounting or financial concept in general terms. I will start with easy topics, and move on to more complex topics over time.

Today’s topic is “Understanding the Income Statement.”

While the Balance Sheet is a snapshot showing a company’s assets, liabilities, and equity at a point in time, the income statement presents the financial results of a business over a stated period of time, usually for a month or a year. It shows revenues and expenses for this period, and the resulting profit or loss. The income statement is tied in with the balance sheet as a profit or loss over a period of time will be reflected in a corresponding increase or decrease in equity on the balance sheet.

Although there can be many ways of showing an income statement, it is usually shown in the following format:

  • Sales (or Revenues) – These are gross sales of a business.  Some companies show all revenues as one figure, while other companies may break their revenues down into types or categories.
  • Cost of Sales – These are costs directly related to the manufacturing or development of a product being sold. Cost of Sales include purchases, direct labour relating to production, and any other costs that are incurred to produce a product.
  • Gross Profit – This figure is Sales minus Cost of Sales.  The gross profit figure, especially in terms as a percentage of sales, is very important for companies, as it indicates how efficiently you are producing your product. The gross profit percentage should be consistent from year to year, and close to or better than industry averages. The gross profit also indicates whether a company is able to pay its administration expenses.
  • Administration Expenses – These are costs related to a company’s administration, as opposed to Cost of Sales which are manufacturing costs.  Such expenses include advertising and promotion, amortization of assets, bad debts, bank charges, dues and fees, insurance, interest costs, management salaries, office costs, rent, repairs and maintenance, telephone and utilities, travel, and administration salaries.
  • Income From Operations – This is Gross Profit less Administration Expenses, and sometimes is referred to as Income Before Taxes.
  • Other Income (Expenses) – Unusual items that do not occur on a regular basis are shown here. This may include gains or losses on the sale of assets, insurance settlements,  or other gains or losses not related to regular company operations.
  • Income Tax Provision – This is the taxes which will be owing on the recorded income above.
  • Net Income – This is the final net income for a company for the period being reported on.

The final net income figure is added to the previous equity figure on the balance sheet to reflect current equity.

Matching Income and Expenditures – There are three basic accounting principles related to the income statement:

  • Sales or revenues are matched with the reporting period. The method used to record sales in a particular period should be consistent from year to year.
  • Cost of Sales are matched with Sales being reported on. Any costs related to unsold products should remain in inventory.
  • Administration Expenses are matched with the period being reported on.

I hope you will enjoy my blogs and find them useful. My next topic will be “Understanding the Cash Flow Statement.”  Please drop by.

 

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