Three factors you should know about an Income Statement
The income statement is one of the core financial statements used by business owners and their accountants to reflect the financial health of the business during a specific accounting period. Other crucial financial statements include the balance sheet, the statement of cash flows, and the statement of shareholders’ equity. The income statement has several names by which it is alternately known, including statement of operations and profit and loss statement.
What does the income statement show?
There is some confusion about what the income statement shows, as the name seems to imply that it would only show the money coming into a business. In truth, the idea is to show the profitability of the company during a specified period of time. Since profitability is a function of both the money coming in and the money going out, the income statement tracks both revenues and expenses.
Ultimately, the income statement should provide information about a company’s gains/profits or its losses. Depending on the reporting period that a company uses, the income statement can be a monthly statement, quarterly implemented, or an annual statement.
Why is the income statement important?
Many parties could be interested in the income statement, as it provides a clear view of whether a company is profitable or not. For example, banks or creditors might be unwilling to work with a business that shows consistent operational losses on its income statement.
In addition to lenders and creditors, this type of statement is essential to managers, stockholders, investors, the government, labor unions, competitors, other businesses considering mergers or acquisitions, and more. All these entities have reasons to be interested in how much money a company is bringing in, how much money it has going out, and whether those numbers reconcile to put the company in the red or the black.
How information on income statements is presented
Every income statement follows the same basic structure. Specifically, every income statement breaks down into two categories. The first category is “Revenue and gains.” The second is “Expenses and losses.” Line items in each section should outline revenues or losses due to both primary activities and secondary activities. A “primary activity” might be producing and selling a product (for a manufacturer) or selling existing merchandise inventory (for a retailer). A “secondary activity” would be a profit or loss related to a peripheral activity, or not related to the core activities of producing, buying, or selling. An example would be a gain or loss related to a lawsuit settlement. Each activity should be recorded as a profit or loss and should represent the amount of money a company gained or lost through a specific activity.
Both sections of the income statement should include specific line items that outline individual transactions. For instance, if a company rents out a piece of equipment it isn’t using, the income from that rental would be recorded as a gain from a secondary activity. However, the statement should also ultimately add up those line items into financial insights spanning the entire reporting period. Cost of sales/cost of goods sold, total operating expenses, revenue expenses, administrative expenses, net income or net profit, operating profit, and gross profit should all be totaled at the bottom of the statement.
Income statements are vital documents, both internally and externally. They provide crucial information about a company’s operations, its total profits or total expenses, and its ability to make money. In turn, they can inform operational or management decisions, help investors make smart decisions, assist creditors or lenders with risk assessment, and more.
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