Financial Statements - Income Statement

August 29, 2023

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An Income Statement, also called a Profit and Loss Statement, shows all revenues and expenses between a period start date (usually the beginning of a month, quarter, or year) and a period end date (usually either today or the end of a month, quarter, or year). It complements the information on a Balance Sheet, and explains the change in Owner’s Equity since the end of the prior period. Income Statements are typically produced by your accounting software, but can also be assembled manually - often using spreadsheet software.

Income Statements also provide the starting point when analyzing how much cash a business generated or used during a period.

Income Statements have two main sections:

Revenues: amounts earned from sales during the period
Expenses: amounts spent to operate the business and generate sales during the period

Many Income Statements will either show

Values in each account for two comparable time periods, or
“Actual” versus “Budget” amounts during a single time period

to allow you to better assess the performance of the business. A dollar change or percentage change column can often be included at the right, as these are often the most common calculations that interest readers.

A simple Income Statement is shown on the next page. Typical sections and accounts you will see for small businesses are briefly described below.

Revenues or Sales are always presented first, at the top of the report. Some businesses report just a single revenue number, while others choose to show multiple revenue lines - one for each business segment or product line. Businesses can choose how they report revenues, but the Total Revenues number will be the same no matter what.

Cost of Goods Sold (COGS). These expenses can also be reported in multiple lines if desired - typically one for each business segment or product line. For a business that sells products, Cost of Goods Sold includes all costs associated with purchasing, manufacturing (if applicable), and storing items before they are sold. For a business that sells services, Cost of Goods Sold includes the cost of all labor and supplies directly related to client projects

Subtracting Cost of Goods Sold from Revenues produces Gross Margin (also called Gross Profit), which is shown immediately below Cost of Goods Sold. Sometimes Gross Margin is divided by Total Revenues, and included as a Gross Margin % on the income statement. This is an important number to keep close track of in most businesses, particularly in inflationary times. It shows the amount of money generated by Revenues that is available to cover other expenditures during the period.

Expense accounts shown on Income Statements will vary from one business to another. If too much detail is shown, an Income Statement can become too long and less useful. If too little detail is shown, an Income Statement may not be as helpful when trying to understand business performance during the period. It’s a balancing act.

Large expenses, such as Payroll, Payroll Taxes, Benefits, and Rent are almost always useful to show in their own accounts because it is important to be aware of when they change.

It can often be useful to set a minimum dollar amount needed to justify having a separate account, and consider consolidating accounts whose totals fall below it. For example, most companies will have a catch-all Office Supplies account instead of separate accounts for Paper Clips, Staples, Pencils, Erasers, Post-it Notes, etc. because none of underlying expense areas add up to a large enough number.

Some organizations show two sections on their Income Statement:

Operating Income - Revenues and expenses that pertain to normal business operations
Other Income / (Expense) - Unusual or one-time revenues and expenses. Can include interest expense.

This approach can make budgeting for next year easier, as items under Other Income are often not included in next year’s budget. The sample Income Statement above does not include an Other Income section.

Depreciation describes the amount of a Fixed Asset’s useful value that has been “used up” since it was acquired. Land does not depreciate. Buildings and Equipment do. On an Income Statement, the Depreciation expense shows how much of the original cost, or “Book Value”, of Fixed Assets was expensed during the period covered in the report. As a result, taxable income is reduced. Depreciation is called a “non-cash expense”, because it does not correspond to money that left your bank account during the period if the Fixed Assets were purchased in a previous period.

What number should you look at to determine a company’s profitability? If you want a quick sense of:

Cash generated by the company, then Net Operating Income before depreciation is a good place to start. This will have to be adjusted if other significant sources or uses of cash exist (for example for loan principal payments, or if fixed assets were purchased or sold).
The company’s “return on investment”, Net Income Before Taxes is a good place to start because this number reflects the cost of fixed assets needed to operate the business.

Different business types will often emphasize different measures when analyzing their Income Statement. Understanding why things changed as they did is very useful when managing a business. The following resources introduce some common approaches to analyzing Income Statements and financial statements in general:

To ask questions and/or learn more about financial statements, register for a “Financial Statements” workshop in the SCORE workshop calendar or request to meet with a SCORE Mentor (a free service).

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