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Beginner's Guide to Financial Statements - Income Statement

By Edited Nov 13, 2013 0 0

The financial statements of a company consist of 3 main parts – (i) the income statement, (ii) the balance sheet and (iii) the statement of cash flows. This guide will explain the basics of the income statement, using the example of a fruit-seller’s business.


Fruits(88477)

The Income Statement

The income statement, also known as the profit & loss (P&L) statement, shows how the revenue (money received from customers) is transformed into net income (the “left-over” after all expenses have been accounted for). The income statement is for a specific period (usually 1 year or 1 quarter). It can help to show managers and investors whether the company made or lost money during the period.

A simple income statement could look like the one below. Actual statements could be more complex and have more details, but follow essentially the same structure.

Income Statement of Fruit-Seller Company X for the year ended 31 December 2011

 

Revenue

$1,000

Less: Cost of Goods Sold (COGS)              

($400)

Less: Selling, General & Administrative (SGA) expenses

($200)

Less: Other expenses

($150)

 

Net Income

 

$250

 

Let’s go through each item in turn, using the fruit seller as an example.

Revenue

Revenue, also known as Sales or Sales Revenue or the “Top line” (since it is the first line of the income statement), is the amount earned from customers over the period. (Note: Under accrual accounting, this is typically not equivalent to the amount of cash received). In the case of the fruit-seller, the revenue for each item or transaction is equal to the price of the fruit sold multiplied by the quantity of fruit sold. In the income statement, the revenue shown would be the total of all these for the period.

Cost of Goods Sold (COGS)

The Cost of Goods Sold (COGS in short), also known as Cost of Sales, is usually the first expense or cost item on the income statement. As the name suggests, it refers to the cost incurred by the company in purchasing the goods from its supplier (or in manufacturing the goods, if it is a manufacturer). In the case of the fruit-seller, the COGS would be the total cost of the fruits (sold during the period) that the fruit-seller incurred in buying them from its supplier.

Selling, General & Administrative (SGA) Expenses

Selling, General & Administrative (SGA) Expenses are a category of expenses incurred by the company. (Note: Not all companies use this classification.) Selling expenses refer to the costs incurred in the selling of the product – including advertising costs, sales commissions, salaries of salespeople. General & Administrative expenses refer to the costs needed to run the business – including salaries of office or executive staff, legal fees, utilities, insurance and office rental. In the case of the fruit-seller, this would include the accountant fees and water & electricity costs, for example.

Other Expenses

Other Expenses comprise the remainder of the costs. Often, businesses would classify their expenses in different ways from what I have described above, but the nature of the expenses would be similar. The other expenses incurred could include depreciation costs, financing costs (e.g. interest on bank loans, bank charges) and income tax expenses. For example, if the fruit-seller had borrowed money from the bank for his business, the interest expenses would be reflected in the income statement.

Net Income

Net Income, also known as Net Profit, Accounting Income, Profit or the “Bottom Line” (since it is the last line of the income statement), is the remainder after all the expenses is deducted from the revenue. It represents the profit for the period that is attributable to the shareholders. When accountants refer to whether a company is profitable or not, they usually mean whether the net income is positive (company is profitable) or negative (company is making a loss). In the latter case, the net income is referred to as a “net loss”.

Summary

From the simple income statement presented above, you can see that the Fruit-seller Company X has earned $1,000 in revenue from sales (of fruit) to its customers. These fruit cost a total of $400 when the fruit-seller purchased from its supplier. The fruit-seller also incurred $200 in selling, administrative & general expenses and $150 in other expenses. This leaves a net income of $250, which means that the fruit-seller was profitable for the year 2011.

Well, this is the bare bones of the income statement – hope this article provides a good beginning to understanding this part of financial statements. Please feel free to comment or ask questions on anything that is not clear, so that I can improve this article. Thanks!


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