The Income Statement

Income statement The income statement is also known as a profit and loss statement (P&L). It is a financial statement that summarises a business's revenues and expenses over a specific period of time. Legally, they would be for a financial year and would be submitted with your tax returns. In the business itself it would traditionally be for the past month, but depending on the shareholders and the type of business it could be for one (1) week at time.

A word of advice is to always look up acronyms when you do not recognise them. Different countries, different accountants, international standards, they sometimes use different acronyms for the same thing.

The primary purpose of the income statement is to show whether a business made enough gross profit to have paid for the stock sold and covered all the expenses. If it made sufficient profit to settle all these bills then it made a profit, but if not it made a loss.

At a very simplistic level, profit means that there is surplus cash and this could be shared by the shareholders. A loss means that the business cannot pay its bills and if the business has no cash reserves, then the shareholders can contribute more cash to the business to allow the business to settle its debts. This is dependent on the legal structure of the business and the applicable law in your country. See on document on legal entities and options.

Practically, the business would not distribute all profits monthly but would retain spare cash in the bank. It could be in a separate bank account. Then surplus cash can be transferred in from the trading bank account if there is a surplus or out if not. All businesses should retain some surplus known as Retained Income. This is protection against a bad trading period. Shareholders do not want to receive requests too often, to put more money into the business. If the business is properly run and profitable, there will be no need for further cash inputs by shareholders.

Remember that in some countries shareholders are not legally responsible for business debts unless they provided personal sureties, but the directors are. This is applicable in many countries, but you need to ascertain how your business is registered in your country and the associated legal risks and benefits thereof. It would be helpful to understand your options before you start a business, so a visit to your local accountant and lawyer for both to advise you on the positives and negatives of your various options.

The modern approach is to have a summary income statement which only shows the totals as well as a detailed income statement in the traditional format. The summary income statement is ideal for the CEO and shareholders to have a quick look at and understand the financial situation with respect to profits and losses. These terms can vary for many reasons, albeit there are international standards defining these terms. A new name for this document is Statement of profit or loss. The detailed income statement allows for doing a proper analysis. The first line on the income statement is one of the following descriptors - Sales, Revenue, Income, Income from trading activities. This is the total amount of money earned from the sale of goods or services during the period. Revenue is often referred to as sales revenue or simply sales. There could be a second income line entitled Other Income. This would be income from a variety of sources such as the sale of old assets, rental of spare rooms in the office, or any income that is not from selling the core business’ products and services. It could also be located lower down on the financial statements and linked to the relevant expenses associated with the Other Income under the heading Other Expenses, as it too is not related to core income and expenses. This is simply to account properly for all revenues and expenses in the business.

Cost of Goods Sold (COGS) - this represents the direct costs associated with purchasing or producing the goods or services that were sold during the period. COGS. There are various costing methodologies that can be used, and these are contained in a separate document on costing methodologies. Income + Other Income = Total Income Total Income - COGS = Gross Profit After calculating the Gross Profit, the next heading is Operating Expenses. These are the costs incurred in the day-to-day operations of the business. Operating expenses can include items such as salaries and wages, rent, utilities, marketing expenses, depreciation, and administrative expenses. Depreciation is an allowable tax deduction to compensate for wear and tear on the applicable assets. This is deducted as an expense but is added back later to increase profits as appropriate, as it is not a cash expense deduction. All depreciation deductions are recorded and accumulated in the Balance Sheet.

Operating Income (Operating Profit): -This is calculated by subtracting operating expenses from gross profit. Operating income represents the profit earned from the company's core business operations before considering interest and taxes.

Gross Profit – Total expenses = Operating Profit Once the Operating Profit has been calculated there are calculations done. They too are separated as they can unfairly influence the profit figure and should not. These calculations adjust for these important yet indirect expenses to provide the final accurate Nett Profit figure.

These calculations/formulae are indicated below: -Nett Profit – Interest on Finance = Nett Profit After Interest, Before Tax Nett Profit – Tax = Nett Profit After Interest, Tax Nett Profit + Depreciation = Nett Profit After Interest, Tax no DepreciationA sample income statement would look like this without the details: -Operating Revenue 1,000,000COGS -600,000Gross profit 400,000Operating Expenses Selling and Administrative Expenses -200,000 Depreciation -40,000Operating Income (Operating Profit) 160,000Non-Operating Expenses Interest Expense -20,000 Depreciation +40,000Income Before Taxes 180,000Income Taxes (calculate based on applicable tax rate) -Tax Net Income (calculate after deducting taxes)