What is an Income Statement?
The income statement is one of the four main accounting statements. The statement shows the profitability of a business over an accounting period. The accounting period can be any length but is usually a month or a year.
It is sometimes referred to as a statement of operations, income and expense statement or a profit and loss account statement.
End of an Accounting Period
At the end of an accounting period the business prepares a trial balance. From the trial balance it transfers revenue accounts to the credit of the income statement, and expense accounts to the debit of the statement.
The statement now shows the revenue less the expenses for the period, referred to as net income.
Net income = Revenue – Expenses
In the net income formula above revenue refers to the monetary amount from the sale of goods in which the business normally trades and which were bought for the purpose of resale, and expenses refer to a resource acquired by a business for monetary expenditure which has been used up during an accounting period.
For a simple business, if revenue is greater than expenses net income is positive and the business has made a net profit, if revenue is less than expenses net income is negative and the business has made a net loss.
A business can also have non-operating income and gains and non-operating expenses and losses. The income statement format is then represented as follows.
Net income = Revenue – Expenses + Non-operating income – Non-operating expenses + Gains – Losses
The term non-operating refers to activities outside the normal trading activities of the business. Non-operating income refers to items such as interest and dividend income, and gains refers, for example, to the profit on the sale of an asset. Non-operating expenses relates to items such as interest expenses, whereas losses refers, for example, to losses incurred on the sale of an asset.
Income Statement Example
The statement format for a company for annual reporting purposes is legally defined. However, for management account purposes the layout should be in the format most useful for managing the business.
The example below shows a typical and useful format for management. The level of detail for each item will depend on your business, and who is using the information. For example, revenue could be broken down by product category, or operating expenditure could be analyzed by either the nature of expenses (advertising, rent etc) or, as shown below, the function of expenses within the business (sales and marketing, administrative expenses etc), whichever provides information that is reliable and more relevant.
| Revenue | 100,000 |
| Cost of goods sold | 45,000 |
| Gross profit | 55,000 |
| Research and development | 10,000 |
| Sales and marketing | 15,000 |
| General and administrative | 5,000 |
| Operating expenses | 30,000 |
| Depreciation | 10,000 |
| Operating income | 15,000 |
| Finance costs | 5,000 |
| Income before tax | 10,000 |
| Income tax expense | 3,000 |
| Net income | 7,000 |
It should be noted in the above example that the income and expense statement is for a fixed accounting period, (month ended December 31 2021), relates to a past accounting period and shows historical cost information, and may include estimates.
Other statement formats are available including those discussed in our posts on the multi-step income statement and the trading profit and loss account. A typical sample statement layout for a publicly listed company is shown in the Annual Report for Apple below.
Cash Flow vs Income and Expense Statement
The income and expense statement has nothing to do with cash. It does not show how a business earned or spent its cash, it shows the profit or loss of the business for the accounting period.
For example, if on the 1st January a business pays insurance of 24,000 for the year, the cash flowing out of the business is 24,000. However, the monthly statement for January would only show an expense of 2,000 (24,000 / 12 months), as this represents the insurance expense for that month.
The Need to Understand the Statement?
The income statement is important for many reasons:
- Management should use the income and expense statement to identify whether the business has a net income for the period. The important figure is the final line net income. It should also use it to establish % relationships between expenses and revenue, to spot trends in operating income ratios, and for comparison of actual results against a budget.
- They are used by suppliers to decide on whether credit is given as they identify the profitability of the business.
- Bank Managers utilise the income and expense statement as they base their lending ratios on certain aspects of it, for example Interest cover = Income before interest and tax / Interest paid is used to determine whether the income the business is making is sufficient to cover the interest payments on their loan.
- The basic statement is used by investors to decide whether to invest or not and at what price. For example they will look at the income before tax to establish their likely return on investment.
Any number of people could be using your income and expense statement to make decisions about your business. It is important that you have an understanding of what information the income and expense statement is providing and what that information is telling you.
Last modified June 7th, 2022 by Michael Brown
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.
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Posted By: Michael Brown Income Statement, Tutorials
June 7, 2022
Income Statement Basics
As an expert in accounting and financial management, I bring to the table a wealth of experience and knowledge gained from over 25 years working as a chartered accountant and consultant. My expertise extends to various industries, and I have served in roles such as CFO, controller, manager, and auditor. Throughout my career, I've built financial models, managed small and medium-sized companies, and run my own businesses. My educational background includes a degree from Loughborough University, and I am the founder and CEO of Double Entry Bookkeeping.
Now, let's delve into the key concepts discussed in the article about Income Statements:
1. Income Statement Overview:
- An Income Statement is one of the four main accounting statements.
- It reflects the profitability of a business over a specific accounting period, typically a month or a year.
- Also known as a statement of operations, income and expense statement, or profit and loss account statement.
2. End of an Accounting Period:
- At the end of an accounting period, a trial balance is prepared.
- Revenue accounts are transferred to the credit of the income statement, while expense accounts go to the debit of the statement.
- Net income is calculated as Revenue – Expenses.
3. Net Income Formula:
- Net Income = Revenue – Expenses.
- Revenue refers to the monetary amount from the sale of goods, and expenses refer to resources acquired by a business for monetary expenditure used up during the accounting period.
4. Non-operating Income and Expenses:
- Non-operating income includes items like interest and dividend income, while gains refer to profits on the sale of assets.
- Non-operating expenses encompass items like interest expenses, and losses refer to losses incurred on the sale of assets.
- The extended net income formula accounts for non-operating elements: Net Income = Revenue – Expenses + Non-operating income – Non-operating expenses + Gains – Losses.
5. Income Statement Example:
- An example layout for an income statement is provided, detailing revenue, cost of goods sold, gross profit, operating expenses, depreciation, operating income, finance costs, income before tax, income tax expense, and net income.
6. Cash Flow vs. Income and Expense Statement:
- The income and expense statement focuses on profitability and does not reflect cash transactions.
- It highlights the importance of distinguishing between cash flow and income when assessing business financials.
7. Importance of Understanding the Income Statement:
- Management uses the income statement to identify net income, establish % relationships between expenses and revenue, spot trends, and compare actual results against a budget.
- Suppliers use it to assess the profitability of a business.
- Bank Managers base lending ratios on aspects of the income statement.
- Investors use it to make investment decisions, considering figures like income before tax to determine return on investment.
In conclusion, a robust understanding of the income statement is crucial for various stakeholders, including management, suppliers, bank managers, and investors, to make informed decisions about a business's financial health. The article emphasizes the importance of interpreting the information provided by the income statement for effective financial management.
