Understanding the Income Statement
This is the second post for the series on understanding your financial statements. We began with the balance sheet. If you haven’t had a chance, you can check it out here. This week we will discuss the income statement and then next week will be the statement of cash flows. I will end this series on how to analyze all three financial statements to get an understanding on how your business is doing financially. I truly hope you find this helpful in your business.
The Income Statement is most commonly referred to as the P&L statement or the profit and loss statement. Although that is an accurate description, the income statement is the “official” term. This financial statement is the most looked at of the three financial statements however when viewed by itself, the overall financial health of your business may not be accurately portrayed.
The income statement shows the profitability of a business during a specific timeframe. The heading of the income statement will state the time period that is covered. This financial statement shows the revenue, expenses, gains and losses of the business, but doesn’t show the amount of cash coming in or going out. At the end of the statement, the net profit or loss is given thus telling a business owner whether they are making or losing money. The basic equation for the income statement is as follows:
Net Income = (Revenues + Gains) – (Expenses + Losses)
Let’s look at the breakdown of the income statement.
Revenue from primary and secondary activities are your operating and nonoperating revenues. Revenue occurs when money is earned, not when it is received. Gains are gains from the sale of a long-term asset when the gain is more than the book value of the asset.
Expenses are incurred to earn normal operating revenues and there are also secondary expenses from nonoperating activities such as an interest expense. Losses are incurred from activities such as the sale of long-term assets.
The difference of revenues and expenses equals the net income or net loss during that time period. It is important to remember that this financial statement shows the profitability of your business, but it does not show the overall health of your business without reviewing the balance sheet and the statement of cash flows.
Next week we will discuss the statement of cash flows and why it is important to determine your business’ financial health.