The income statement: Money coming in and going out

Open full sized image

Revenue minus expenses equals profit or loss.

Encyclopædia Britannica, Inc.

Do you own your own business, or shares of stock in some of your favorite companies? That’s great, but how can you tell if these businesses are doing well? You need to know if a company is making any money—and whether it’s more than they spend to run the place.

For companies big and small, accountants use an income statement to keep track of money coming in (revenue) and money going out (expenses).

The income statement is a useful way to see how a company makes money and how it spends it. You can look at an income statement for just one day or over a month, a quarter, a year, or several years. The income statement is sometimes called a P&L because it shows a company’s profit and loss:

Revenue – expenses="profit" (if the number is positive) or loss (if the number is negative)

An income statement has a typical structure, no matter what the type of business. Companies can use the income statement to see not only their net profit, but also where and how money is made and lost.

Revenue. Revenue is another name for income; it’s money that comes into a business from selling goods or services. A company might list detailed types of revenue. For example, a preschool might list tuition, registration fees, lunch fees, and earnings from fundraising, whereas a coffee shop might list beverage sales, food sales, gift cards, and merchandise as specific types of revenue. Revenue is reduced by any discounts or refunds given, as well as by returns, to calculate net sales.

Cost of goods sold. Some businesses break out expenses specifically related to their sales, such as labor, parts, or materials used to make a product. That’s so they can see how the revenue from their sales compares against the expenses directly required to generate that revenue.

Gross profit="revenue" – cost of goods sold

General and administrative (G&A) expenses. G&A includes all the rest of the expenses needed to run a business.

Operating income="gross" profit – general and administrative expenses

Operating income shows the profit or loss from a company’s regular business operations. Some people use the term “earnings before interest and taxes” (EBIT) for operating income.

Other income and expenses. Interest income (that is, interest earned on investments) and interest expenses (interest paid to lenders) are included in “other” income and expenses. This category might also include gains and losses from investments or foreign transactions. Taxes paid on business revenue are included in the general category of other expenses, although some businesses break it out to show pretax income on a separate line.

Net income="operating" income – other income and expenses

Net income is the final number on the P&L and flows into retained earnings on the balance sheet.

Companies (and households) run into all kinds of expenses:

There are two general methods for tracking income and expenses: cash basis and accrual basis.

Cash basis is the method of tracking income and expenses by the cash that comes in compared to the cash going out. Many tax returns and most personal financial statements use the cash basis. Every dollar of cash that’s deposited into the business is considered income; every dollar used to pay for something (except for debt) is considered an expense. Depreciation (see the sidebar) is not listed on a cash basis income statement, since no cash is spent.

Accrual basis is the general accounting method used by most companies in the U.S. The accrual method records an expense when the company gets a benefit from a purchase, even if it’s not yet paid for.

Suppose a company rents its storefront for $2,000 a month. The lease starts on the first of the month, but the rent isn’t due until the fifteenth. As of the first of the month, the company knows it owes rent, so it would record a rent expense of $2,000 under the accrual method. If the company keeps its books on a cash basis, they would not record the $2,000 rent expense until the fifteenth, when it is actually paid. Accrual basis books also include depreciation expenses.

Credit card expenses: Cash or accrual? Expenses paid with a credit card are typically considered cash basis expenses when they are incurred, not when they are paid off. So if a company pays for some office supplies on its credit card, the transaction will show up right away as an office supplies expense, even if the credit card payment isn’t due for another month.

Every business wants to make more money than it spends. The way to find out if it’s making a profit is to look at its income statement, which shows how the company makes and spends money over a period of time. If you’re the owner, analyze the monthly and annual flow of money in and out as tracked on the income statement to monitor your business’s health.