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Understanding Financial Statements: Part 1 – Income Statement

6 mins read

This article explains the 1st of 3 important financial statements: Income Statement.

As Cuba Gooding Jr. famously said in Jerry McGuire: “Show me the money!” Why is this relevant? Because that is precisely what financial statements do; they show you the money! Financial statements show the details of where a company’s money comes from, where it goes, and where it is now. I think most of us can agree that money is pretty important when it comes to running a business, which makes it just as important to understand the different financial statements that can be accessed from accounting software in order to see exactly what is happening with the company’s money. Beyond guiding business decisions such as budgeting, financial statements also become essential when applying for loans, and for investors, market analysts, and creditors. In this article we explain the first highly valuable financial statement that is important for business owners to understand: the income statement.

What is an Income Statement?

This statement is also sometimes referred to as the Profit and Loss statement. The information in this statement covers a period such as a month, a quarter, or a year, and can be adjusted to the time period that you want to see. This statement is typically considered one of the most important, as it details the performance of the business. The main purpose of this statement is to show the profitability of the business and the financial results of the business activities. It can also be highly effective for showing if sales and revenue are increasing or decreasing when compared with other time periods. The income statement is often aligned with the budget, as business owners can analyze the income and spending compared to the budget for the period.

What is Included in an Income Statement?

The information included in this statement is the revenue, expenses, and net income. The formula for an income statement is:

    • All revenues are detailed for the time period
    • All expenses are detailed for the time period
    • Subtracting the total expenses from the total revenue gives the net income for the period, which is also known as the profit (+) or loss (-).

Revenue

Revenue is the income for the business. There are 3 types of revenues that a company’s income typically falls under.

    • Operating Revenue: Income earned from selling a company’s products or services. This is the revenue generated from core business activities.
    • Non-Operating Revenue: Income earned from non-core business activities, meaning they fall outside of the primary function of the business. This could include interest earned on cash or savings in a bank account, rental income from property, income from an advertisement displayed on the business’s property, or royalty payment receipts.
    • Other Income: Revenue earned from other activities such as capital gains from the sale of long-term assets like land or vehicles.

Expenses

Expenses include the money that is spent.

    • Primary Expenses: Expenses that are required to earn revenue from the primary activity of the business. This would include the cost of goods sold (COGS), selling, general and administrative (SG&A), depreciation or amortization, and research and development (R&D). Typically these would be expenses such as payroll, sales commissions, and utilities.
    • Secondary Expenses: Expenses linked to secondary business activities such as interest paid on loans or debt, and capital losses.

Net Income

When revenue is higher than the expenses, it results in a profit for the business. When expenses are higher than revenue, it results in a loss for the business.

Example of an Income Statement

In the below example, we see the details of the company’s revenues, their expenses, as well as the net income. As the revenues are higher than the expenses for the time period selected of 1 year, the result is a profit.

Importance of Income Statements

This article has explained the important uses for an income statement, as well as the sections that are included within them. Revenues detail the income sources and totals for the business, expenses detail the spending of the business, and the net income shows if there was a profit or loss for the period the report reflects. After gaining a better understanding of these statements from this article, we recommend you take a look at an income statement for your business to see the value this information can offer!

Next up in this series on financial statements, Part 2 describes balance sheets.

Download this resource Understanding Financial Statements: Part 1 – Income Statement.

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