The Purpose of the Income Statement

  
 

The Purpose of the Income Statement

The income statement is a summary of a company's income producing activities over a specific period. Remember that the balance sheet is a snapshot of a particular moment. The income statement shows what happened in the period leading up to that moment. Sample 5 shows a typical income statement.

Income statements are also sometimes called the statement of profit and loss (or the P&L). Although there will be some minor changes in presentation, income statements all have some things in common:

  • Revenue: This number is always presented at the top, before any expenses.

  • Cost of goods sold (COGS): This expense is always shown next. COGS is the cost of the products that were sold during the period (ie., the items for which you received the revenue). If a company sells services instead of goods, there will be no cost of goods sold line.

  • Gross margin: The total for the gross margin line will equal revenue minus cost of goods sold. In all cases, the gross margin should be a positive number, because it reflects only the cost of the product you sell. For example, if you sold 100 gadgets at $4.75 each, for which you paid $2.15, your revenue would be $475, and your cost of goods sold would be $215, leaving you with a gross margin of $260. The only way that the gross margin would be negative would be if you were selling goods for less than your cost to purchase or manufacture them. You wouldn't stay in business very long doing that!

  • Expenses: Some income statements do not categorize expenses, but those that do usually separate them into sales, administrative, and general expenses. Sales expenses are those costs directly related to the sales process: your marketing manager's salary, advertising, and promotion. Administrative expenses would include the costs of your premises (rent), receptionist's salary, office supplies, and anything else necessary to your "back office" operations. The general expenses category is the catchall basin for everything else.

  • Esrnings before income tax (EBIT): EBIT will be the figure you are left with once you total your expenses, then deduct them from your gross margin. EBIT shows your total net profit before your income tax expense for the period it is calculated. However, the EBIT number may be different than the number that you are taxed on in your income tax returns for a number of reasons (a discussion of which is beyond the scope). If a company is not incorporated, there will be no EBIT, because there will be no income taxes shown. An unincorporated company is not subject to its own taxes; rather its owners are taxed on the company's earnings as part of their personal taxes.

  • Income taxes: As discussed above, this figure will appear only on a corporation's income statement. The income tax expense represents the tax expense related to the current period (listed at the top of the income statement). It mayor may not be different from the income tax payable number on the balance sheet.