What Is An income statement?

An income statement can be compared to a theater show. It tells a story about the show's activities over a period of time. A firm's income statement tells the reader what the firm earned by selling its products or services, what activities it undertook to earn that revenue and how much those activities cost. Like some shows, it can have a happy ending; like others, it can be a horror show. The opening scene, that is, the first item on the income statement, shows what the firm's revenues are, that is, what it earned from the sale of its principal products or services.

Cost of goods sold follows. If the company in question is a retail or wholesale firm, cost of goods sold represents the cost to the firm of the merchandise it sold plus all the related costs of transportation and taxes incurred to get the product on its shelves and out the door. If the firm is a manufacturer, calculating cost of goods sold is considerably more complicated. It involves calculating the cost of materials and labor and estimating the overhead that went into manufacturing the firm's products. For a service firm, cost of services provided represents the labor and overhead expended to provide the firm's services.

Gross profit is a particularly important number on the income statement. Not only is it usually one of the larger amounts on the income statement, but it also represents the amount of money the firm has available to cover its selling and administrative expenses, interest and taxes and provide a return to the firm's owners. If gross profit is not adequate, the firm is not going to be profitable. Selling and administrative expenses are obvious from their titles. Like other expenses, depreciation is a cost of doing business and is deducted from revenues to determine net income. Unlike other expenses, depreciation is a non-cash expense. That is, the firm writes a check and reduces its cash balance when it pays for wages, utilities and so on. It does not do so when it records depreciation.

When the firm records depreciation expense it does not reduce cash or increase a liability; rather it reduces the book value of the asset being depreciated. As we continue to move down to the income statement, the next significant item is operating income. Don't confuse operating income with net income. Operating income is the income earned from operating the firm's assets. It is a measure of how effectively management has managed the assets with which they have been entrusted.

Note that "other income and expense" is listed after operating income. Interest expense and other non-operating income and expense items will always be shown in the section of the income statement. Interest expense is shown because it is not an operating expense; it's a financing expense. To be successful, management must operate and finance the firm's assets effectively and efficiently. Other taxes a company must pay are scattered throughout the income statement and balance sheet. Sales tax incurred on the firm's purchases will be included as part of the cost of inventory and materials in cost of goods sold, or as part of the cost of the equipment listed on the balance sheet. Property tax will be included as a component of manufacturing overhead, or selling, general and administrative expense.

Tina Smith is an accountant with SageNext Infotech. She is having expertise in project management, accounting operations. With SageNext, she consults the client accountants about the benefit of QuickBooks Hosting. SageNext is a leading QuickBooks Hosting provider, dealing in all kinds of tax and accounting application hosting.


Author:  Tina S Smith
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