What is an Income Statement?
Most business owners have at least heard of an Income Statement or a Profit & Loss Statement. Basically they understand and want to know if they are profitable. If by chance you have not heard of an Income Statement or do not know what it is, basically it shows what Sales (Revenue) came in and what went out (Expenses). The difference is either a profit (you had more revenue than expenses) or a loss (you had more expenses than revenue).
The Income Statement shows a company’s operating results over a period of time and uses the accrual method of accounting. This means revenue and expenses are recorded when a transaction occurs, regardless of when the payment is made or received. For instance, you had a sale in December but received the money from your customer in January. Accrual method requires you to record the sale in December. It is important to note that the IRS requires the accrual method of accounting for your business.
There are three main parts of the Income Statement:
- Revenue: Total sales from products and/or services.
- Expenditures: Total costs and expenses that are incurred to run your business.
- Income: (Revenue less expenses) – How much profit was generated
Expenditures can be categorized in different ways on the Income Statement.
If you sell a physical product you could also have a cost of goods sold expense. This is what it costs to produce or have the item. For instance, you sell t-shirts. You buy the t-shirts for $25 but it cost you $10 for each shirt. Your cost of goods sold is $10.00. Your Gross Profit is $15 which reflects the $25 sale less $10 cost of goods sold. This is an important number for you as a business owner. By separating this cost from your other costs you can ensure that you are not losing money on that particular product.
After Gross Profit, the next expense category is Operating Expenses. Basically operating expenses include everything a company spends on overhead. These expenses are often lumped together into common categories like sales and marketing (S&M), research and development (R&D), and selling, general and administrative expenses (SG&A).
Income Statements do not have to be complicated. The bigger the company the more detailed the Income Statement. If it is a publicly traded company (think stock market) then the Income Statement will be more complex.
The Basic Formula for an Income Statement looks like this:
| Revenue | |
| less | Cost of Goods Sold |
| = | Gross Profit |
| less | Operating Expenses |
| = | Net Income |
Some of the things you as a business owner should look at regularly on your Income Statement:
- Is Revenue growth declining rapidly – if so, what is the reason and what are you doing about it?
- Is your gross margin (Revenue less Cost of Goods Sold) declining – if so, why? Are production costs or supplier costs increasing? This may mean you need to increase your sales prices.
- Are certain expense categories increasing rapidly…they seem more than normal.
- Are you you having a net loss month over month (some businesses are cyclical and having several months of losses is normal…but you need to know that).
The Income Statement is more than just the bottom line. It can really show you what is happening in your business.
I hope that you can see that reviewing and understanding the Income Statement along with the Balance Sheet and Cash Flow Statement can really make a difference in the long term success of your business.
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