An Overview of the Income Statement
As a Small Business Owner, you have likely encountered an Income Statement, or as it’s also known a Profit and Loss Statement. But, what is an Income Statement?
Well, an Income Statement is a foundational financial statement. An Income Statement provides a starting point on which all the other financial statements build. Think of the Income Statement as a scorecard for the inflows and outflows of your Small Business.
We will review the inflows and outflows in more detail when we discuss the Cash Flow Statement. But, the Income Statement summarizes those flows at the line item level.
A line item is a row or category on the Income Statement that includes the aggregation of transactions such as Revenue and expenses.
Keeping that in mind, let’s dig into a few of the specifics that make up an Income Statement.
Income Statement Overview
The Income Statement measures the financial performance of a business over a period. This is a critical distinction of the Income Statement from other Financial Statements. The Balance Sheet, for example, is a snapshot of a specific point in time rather than covering a period.
For Example, the Income Statement may include a period of several years or months, but it has a defined starting point and an endpoint.
An Income Statement may cover January 2013 through December 2013, but it measures all of the financial performance in between those two dates. So, all of the related Revenue, Expenses and numerous measurements of profitability.
The Revenue line item on the Income Statement is an excellent illustration of just what that means.
Revenue is generated over time and is cumulative – suggesting that with each sale the total on the Revenue line increases. So at the end of the period measured, all of the Revenue items are added together to arrive at the final Revenue total. In other words, the Revenue line item on the Income Statement includes all of the Revenue generated during the measurement period.
Below is a visual representation of an Income Statement in Bookvalu. Notice the start and end points and the measurement of this Small Business financial performance over time. In this case, the Income Statement starts with the year 2014 and is forecasted through the year 2022.
That is a high-level summary of the Income Statement. Let’s review some of it’s more common components in a bit more detail.
Components of the Income Statement
As we discussed, an Income Statement can contain many different line items depending on the nature of the business. A line item is a set of transactions that are aggregated on the Income Statement.
For example, all of the expenses needed to run the operations of your business may be included in the Operating Expenses line-item grouping on the Income Statement.
The components that we will highlight below are some of the more common line items you will find on an Income Statement.
Revenue also referred to as Sales, are the funds received from the sale of goods or services that the small business offers for sale. The Revenue line on the Income Statement measures the positive transaction or increase to the revenue account that takes place when a good or service is exchanged for money.
Any discounts on that Revenue are reflected on a separate line item called Discounts/Refunds. The Discounts/Refunds reduce the total Revenue overall but are presented on their line for reporting visibility purposes.
Below is an example of Revenue.
Example: Bob’s Big Rigs sells 18-wheeler trucks. With every 18-wheeler sold Bob books Revenue to the Revenue line on the Income Statement in the amount of the sale.
Cost of Goods Sold
Cost of Goods or Services Sold (COGS or COSS) are expenses directly related to the production or development of a good/service. Think of COGS as the expenses that go into making a product, and without those costs or inputs there would be no product or service produced or available for sale.
Cost of Goods Sold is also presented as a line item and separate from other expenses for analysis and reporting purposes.
Below is an example of Cost of Goods Sold.
Example: Phil’s Pencils buys graphite in bulk in order to fulfill their customer’s pencil orders. Without the graphite, Phil cannot produce pencils, so it is a Cost of Good Sold.
Gross Profit is one of the primary measures of profitability, which shows up near the top of the Income Statement. Gross Profit is the difference between the sale price of a good and the direct cost of producing it. Or in other words, the Sale price less any Cost of Goods Sold. When viewed as a percentage of revenue this is also known as Gross Margin.
Gross Profit = Revenue – Cost of Goods or Services Sold.
Below is an example of Gross Profit.
Example: Steve owns a bakery. Steve sells cakes at $10 each, the Sale price, and the ingredients used to make those cakes, or Cost of Goods Sold, cost $5 each. Steve’s Gross Profit on each cake sold is $5 or 50%.
Operating Expenses are the expenses or costs, related to running your small business. Many times these items are grouped as “Selling, General & Administrative” expenses.
You should think of Operating Expenses as the inputs needed to run your business that is not related to product manufacturing directly. So, in other words, the rent you pay each month to house your production facility is an Operating Expense.
As an aside, the Operating Expense line item is usually one of the larger groupings on the Income Statement. Meaning that what it includes many different expense lines. For this reason, we have in Bookvalu we have decided to include an Expense Statement. The Expense Statement breaks down the Operating Expenses into a bit more detail.
Below is an example of Operating Expenses.
Example: Heather owns a printing business. Heather pays $5,000 per month in rent for her manufacturing facility. The rent is an Operating Expense that Heather needs to run her business.
Operating Income is another measure of small business profitability. The Operating Income line item takes Gross Profit a step further by subtracting Operating Expenses. Operating Income can be viewed as the actual profit of the small business derived from its operations or day-to-day sales functions.
For this reason, Operating Income or EBIT as it is also known is used as a base metric for calculations such as EBITDA and other measures.
Below is an example of Operating Income.
Example: Judy books $100,000 in Revenue, $15,000 in COGS and $40,000 in Operating Expenses for 2014. The Operating Income for Judy’s business is $45,000.
Net Income is the final measurement of small businesses profitability. Colloquially, Net Income is also called the “Bottom-Line” number of a company. The Net Income line item can also be viewed as the profit that is allocated to the shareholders of the small business. This profit can then be distributed to the owners of the company in the form of dividends or reinvested in the company.
The formula for Net Income is as follows.
Net Income = Revenue – COGS – Operating Expenses – Depreciation – Taxes
An example calculation for Net Income is as follows.
Example: Judy books $100,000 in Revenue, $15,000 in COGS, $40,000 in Operating Expenses, $2,500 in Depreciation and pays $16,000 in taxes on her Operating Income for 2014. The Net Income for Judy’s business is $26,500.
What is an Income Statement – Summary
So, what is an Income Statement? Its a summary of financial performance over a period of time specifically related to the Revenue, Expenses, and Profitability of a company. While these are not all of the line items that could appear on an Income Statement, they represent the elements that tell the most about a company, and it’s overall financial performance in the context of Revenue, Expenses, and Profitability. Think of them as the core line items on the Income Statement.
What is an Income Statement – Takeaways
- The Income Statement measures the financial performance of a business over a period of time.
- There are several components of a standard Income Statement, which highlight the Revenue, Expenses, and overall profitability of a business.