Definition: A document generated monthly and/or annually that reports the
earnings of a company by stating all relevant income and all
expenses that have been incurred to generate that income. Also
referred to as a profit and loss statement.
The income statement is a simple and straightforward report on a
business' cash-generating ability. It's a scorecard on the
financial performance of your business that reflects when sales are
made and expenses are incurred. It draws information from the
various financial models such as revenue, expenses, capital (in the
form of depreciation) and cost of goods.
By combining these elements, the income statement illustrates
just how much your company makes or loses during the year by
subtracting cost of goods and expenses from revenue to arrive at a
net result, which is either a profit or a loss. It differs from a
cash flow statement because the income statement doesn't show when
revenue is collected or when expenses are paid. It does, however,
show the projected profitability of the business over the time
frame covered by the plan. For a business plan, the income
statement should be generated on a monthly basis during the first
year, quarterly for the second and annually for the third.
Your income statement lists your financial projections in the
following manner:
- Income includes all the income generated by the
business.
- Cost of goods includes all the costs related to the sale
of products in inventory.
- Gross profit margin is the difference between revenue
and cost of goods. Gross profit margin can be expressed in dollars,
as a percentage, or both. As a percentage, the GP margin is always
stated as a percentage of revenue.
- Operating expenses include all overhead and labor
expenses associated with the operations of the business.
- Total expenses are the sum of cost of goods and
operating expenses.
- Net profit is the difference between gross profit margin
and total expenses. The net income depicts the business' debt and
capital capabilities.
- Depreciation reflects the decrease in value of capital
assets used to generate income. It's also used as the basis for a
tax deduction and an indicator of the flow of money into new
capital.
- Earnings before interest and taxes shows the capacity of
a business to repay its obligations.
- Interest includes all interest payable for debts, both
short-term and long-term.
- Taxes includes all taxes on the business.
- Net profit after taxes shows the company's real bottom
line.
Although the basics of an income statement are the same from
business to business, there are notable differences between
services, merchandisers, and manufacturers when it comes to the
accounting of inventory.
For service businesses, inventory includes supplies or spare
parts--nothing for manufacture or resale. Retailers and
wholesalers, on the other hand, account for their resale inventory
under cost of goods sold, also known as cost of sales. This refers
to the total price paid for the products sold during the income
statement's accounting period. Freight and delivery charges are
customarily included in this figure. Accountants segregate costs of
goods on an operating statement because it provides a measure of
gross profit margin when compared with sales, an important
yardstick for measuring the firm's profitability.
For a retailer or wholesaler, cost of goods sold is equal to
total inventory at the beginning of the accounting period plus any
merchandise purchased, including freight costs, minus the inventory
present at the end of the accounting period. This is your total
cost of goods sold.
Although manufacturers account for cost of goods sold in the
same manner as merchandisers by reporting beginning and ending
inventories, as well as any purchases made during the accounting
period, their approaches are also different because they track
inventory through three phases.
- Raw material is purchased to create a finished
product.
- Work-in-progress is inventory that is partially
assembled.
- Finished products are inventory fully assembled and
available for sale.
Associated with this process are other costs, such as direct
labor and factory overhead. To account for all these costs,
manufacturers usually report them on a separate statement called
the "cost of goods manufactured." This statement is formed by first
listing the work-in-progress inventory at the beginning of the
accounting period. The next listed are raw material and direct
labor. The total cost of materials available for use includes
inventory at the beginning of the accounting period plus new
purchases and freight charges. Subtract the raw material inventory
present at the end of the reporting period from the cost of
material available for use to determine the cost of materials used.
Add direct labor and manufacturing overhead to this amount. This
results in your total manufacturing costs. Add the work-in-progress
beginning inventory present at the end of the accounting period.
This supplies you with the cost of goods manufactured.
In the income statement for manufacturers, cost of goods
manufactured is added to the finished goods inventory at the
beginning of the inventory, resulting in total cost of goods
available for sale. The finished goods inventory present at the end
of the reporting period is subtracted from this amount to produce
the cost of goods sold.
When comparing several income statements over time, you can
chart trends in your operating performance. This helps you chart
future goals and strategies for sales, inventory, and operating
overhead.