Tuesday, 7 December 2021

Understanding the Income Statement

Understanding the Income Statement
11 Dec

What is an income statement?iStock

Also called a profit and loss statement (P&L), an income statement is a picture of your business’ revenues and expenses — and the resulting net profit and loss — over a certain period of time (usually a year).

The income statement is one of the three essential financial documents — along with a balance sheet and cash flow statement — that a public company must report on an annual basis. The income statement is also the only financial statement that the IRS requires, which the taxing agency uses to assess taxes on profits earned.

What is an income statement?

There is no standard format for an income statement, but most will include rows for items like revenue, tax expenses, profit or loss, and comprehensive income. An income statement is primarily meant to inform the reader about the ins and outs of the company’s financials, so the format you choose should clearly identify your expenses. You should have a distinct row for every separate cost, so this chart could get large if you are splitting up your expenses into many categories. You can categorize expenses by type, function or by some other system.

Income statements are useful in many ways. They can help you easily visualize your company’s year-over-year (YOY) and quarter-over-quarter (QOQ) performance. Two or three years of data is often included to enable comparison. Income statements can also be used to calculate various financial ratios, such as:

  • Return on equity (ROE)
  • Return on assets (ROA)
  • Gross profit
  • Operating profit
  • Earnings before interest and taxes (EBIT)
  • Earnings before interest taxes and amortization (EBITDA)

An income statement helps you understand which way your business is headed, which is useful for informed and strategic course correction.

Income statement vs. balance sheet: what’s the difference?

The income statement is the only financial document that provides an overview of your company’s net profit and loss over a period of time. A balance sheet, meanwhile, is a snapshot of a company’s assets, liabilities, and shareholders’ equity at a particular point in time. It basically tells you what your company owns and what your company owes, including the amount of money that shareholders have invested in your company.

While an income statement allows you to understand the dynamics of the money flowing into and out of your business, a balance sheet gives you information to compute rates of return and evaluate your capital structure, which is the manner in which your company is financing its operations and growth.

An income statement is useful because it illustrates a company’s financial trajectory. A balance sheet, on the other hand, is useful because it shows how effectively a company is managing its resources.

Common terms to know

There are a variety of confusing terms you may find on an income statement. Here are some common terms to know:

  • Revenue: Also called sales on an income statement, revenue is the amount of money the company brings in during a certain period or time. This figure incorporates discounts and returns, and indicates gross income from which costs are deducted to figure net income.
  • Expense: An expense is anything a company spends money on in the course of doing business. Business expenses cover a broad range of categories and commonly include things like payments to suppliers, employee pay, subscriptions for business software, leases on facilities, and equipment depreciation. The IRS allows companies to claim some of these expenses as deductions on tax returns, but maintains strict rules as to which expenses quality for tax relief.
  • Net profit/loss: Net profit or net loss is a summation of a company’s financial situation in a given period of time. Expenses and debt are deducted from revenue for a certain period, which determines whether a company brought in more money than it spent (with debt included) or the other way around.
  • Gross profit/loss: Gross profit is the amount of money a company makes in a certain time period after subtracting the amount spent in that same period on making and selling its products (cost of goods sold, or COGS), or on providing its services. Gross loss is the amount of money a company spends to operate in a certain time period. For example, in a given month, if a company makes $10,000 in sales and spends a total of $2,500 on all of its expenses, it has a gross profit of $7,500 and a gross loss of $2,500.
  • Depreciation: Depreciation is the concept that a tangible asset like a piece of equipment loses in value over time. Properly deducting a tangible asset from taxes requires accounting methods that takes into account depreciation over the asset’s lifetime.
  • Amortization: Amortization refers to paying off debt via a fixed schedule of regular installments over a set period. For a business loan with a set interest rate, amortization joins the principal and interest into one total figure that can be payed off over a predetermined number of months or years.
  • Operating income/expenses: Operating income is the money a company earned in a given period due to regular operations, less all operating expenses for that period. Operating expenses are all of the things a company must pay to maintain operations, such as wages, rent payments, utilities, depreciation, supplies, and COGS.
  • Non-operating income/expenses: Non-operating income is business income that comes from sources other than day-to-day operations. Non-operating income sources include things like dividends, investments, foreign exchange and asset write-downs. Similarly, non-operating expenses are costs that don’t arise from a business’s core activities, such as interest, derivatives, settlements, obsolete inventory, and restructuring.

4 free income statement templates for business owners

There is no single correct format for an income statement, so each business owner can choose one that best fits their needs. However, it can be much easier to start with a template that will allow you to plug in your information and create an attractive statement with ease. Here are four free income statement templates:

  • Microsoft Office Template 1: This attractive 12-month Excel template incorporates separate tabs for revenue and expenses, as well as a line graph for easy visualization. It also gives you the option to edit in your browser window.
  • Microsoft Office Template 2: A bit simpler than Template 1, this Excel template allows you to set the time period and gives you blank boxes in which to insert your data.
  • QuickBooks Template: This Excel template is entirely customizable regarding time period and types of revenues and expenses, plus it comes with a completed example.
  • SBA Template: This simple Excel template is a one-page statement for a year-long period, with suggested expense categories included.

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