Summary: Understanding The Income Statement

Understand the Income Statement The Income Statement is one of the financial reports that you should be receiving from your accountant regularly. At least once a month, you should be able to see how your operations are doing. You will be able to react in a timely manner if you can see how your business fares in the market. If you are profitable and hitting your targets, the income statement will show that you are doing the right thing and you can push to achieve more. If you are incurring losses, you can immediately make corrective actions to nudge your business back to the right direction.

Frequency of Reporting

The Income Statement shows if your business is profitable or not for a given period. Bigger companies prepare Income Statements

I've seen three-page long income statements from multi-million companies who have strict financial control on all of their departments. But a shorter income statement works, as well, as long as management is able to get the information they need to make sound decisions.

Regardless of the frequency of preparation and level of detail, all income statements share common elements:

Revenues

Direct Costs (or Cost of Goods Sold or Cost of Services)

Gross Profit

Operating Expenses

Gains and Losses

Revenues

Revenues pertain to the fees earned from providing services or the amounts of merchandise sold. Service companies usually call revenues as Service Revenues or Fees Earned. Manufacturers and merchandisers, on the other hand, have Sales Revenues or Sales on their income statements.

Before we move on to the other elements, let us discuss the ACCRUAL METHOD of accounting. Under this method, revenues are reported on the income statement in the period they are earned or delivered, not in the period when the cash is

On November 1, 2012, Haydz Bakery paid $4,000 for two months advance rent and two months rent deposit (monthly rent is $1,000). On November 30, 2012, the income statement should only reflect a $1,000 rent expense. The remaining $3,000 should be shown as assets on the Balance Sheet ($1,000 Prepaid Rent and $2,000 Deposit).

Gross Profit vs. Net Income

Since Gross Profit is Revenues less Direct Costs, it is primarily driven the goods or services provided by the company. Companies within the same industry normally have gross profit margins within a particular range. (Gross Profit Margin (%) = (Gross Profit / Revenues) x 100)

A high gross profit margin is good because it means that after paying for direct costs from the revenues earning, the company still has more money left over for operating expenses and net income. Companies with high gross profit margins enjoy good office locations and good compensation and benefits for their employees.

Net income, also commonly called the bottom line, is gross profit less operating and financing