What is an Income Statement?

THE PURPOSE

The purpose of any financial statement is to provide information about an entity’s transaction history that is USEFUL for internal and external users. 

You can read more about accounting and the purpose of Financial Statements here (refer to What is accounting blog). 

Financials must also be made using the Accrual Method of Accounting if prepared for external users. (refer to accrual blog).

KNOWN BY DIFFERENT NAMES

Depending on your age, business structure, and personal preference, the Income Statement has been called many things, including:

• Earnings Statement.

• Statement of Earnings.

• Profit and Loss Statement.

• Operating Statement.

• Statement of Operations.

• Statement of Expenditures and Revenues

USED AS A TOOL

The Profit and Loss statement (income statement) is a tool to explain the Performance of an entity over a certain Period of Time.

In other words…

How did we do over the last quarter, year or few years?

NET PROFIT OR (NET LOSS)

The Income Statement will present either a Net Profit or (Net Loss) using the following accounts:  

Revenue (aka sales) =

Sources or inflows of assets, enhancements of assets or reductions of liabilities from operations.

In other words…

When your Core Business Function generates cash or other forms of assets 

Expenses =

Uses or outflows of assets, or increases in liabilities from operations.

In other words…

When Your Core Business Functions uses up cash or other forms of assets.  

Gains =

Increase in equity from activity that is not related to Core Business.

In other words…

If your cash or other assets increased from something you are not in business to do, it is not revenue, it is a gain.

Loss =

Decrease in equity from activity that is not related to core business.

In other words…

If your cash or other assets decreased from something you are not in business to do, it is not an expense, it is a loss”.

*Gains and Losses are very different than Revenues and Expenses because they do not relate to your core business, or what you are in the business to do.

Financial ratios, metrics, and tax returns are all impacted by proper classification.

INCOME STATEMENT EQUATION

The Income Statement is an equation where: 

Revenue – Expenses + Gains – Loss = Net Income (Loss)

The income statement provides answers to efficiency and profitability.

This statement explains how efficient a company is at leveraging Assets, Liabilities, and Equity transactions to generate a profit. (Refer to Balance Sheet Blog).

HELPFUL FINANCIAL STATEMENT RATIONS

Financial statement ratios help users to gather the information important to analyze the entity’s past, current, and future operations:

Some ratios used from the Income Statement accounts include: 

• Gross Profit Margin

• Profit Margin (after tax)

• Earnings Before Interest and Taxes (EBIT)

• Times Interest Earned

• Return on Equity (ROE)

• Return on Total Assets

• Return on Investment (ROI)