Income Statement Simplified and Defined

The Income Statement Simplified

The purpose of the income statement is to present revenues, expenses, net income, and earnings per share for an accounting period.  For the income statement the earnings are normally measured on an accrual basis so the income reported on it is not the same as cash generated during the accounting period.  However some small businesses prefer cash basis due to its simplicity.

Ten Common Sections of the Income Statement

1. Total sales are usually the major revenue source for most companies and cover the net of returns and allowances.
2. Cost of goods sold is the deduction from sales of the costs incurred by the seller for products or services sold and include LIFO, FIFO, and average cost.
3. Gross profit is the first profit measurement in the income statement and is figured by the difference between net sales and cost of goods sold.
4. Operating expenses are broken into four categories that include selling and administrative, advertising, depreciation and amortization, and repairs and maintenance.
5. Operating profit or earnings before interest and taxes (EBIT) is the next step of profit determination, which measures the overall performance of a company’s operations.
6. Other income section contains revenues and costs other than from operations such as dividend and interest income, interest expense, and gains/losses from investments.
7. Equity earnings accounts for cost or equity employed to account for investments in the voting stock of other companies.
8. Earnings before income taxes is the third profit determination measurement
9. Net earnings that expresses the profit after all revenue and expenses reported during the accounting period following the disclosure of income taxe.
10. Earnings per common share are derived from the net earnings, which is the return to the common stock shareholder for every share owned.

Three Formats of Income Statement Presentation

1. Multiple-step – provides intermediate profit measures and should be used for the purposes of analysis.
2. Single-step – groups all items of revenue together.
3. Common-size income statement – displays each income statement item as a percentage of net sales.

References:

Fraser, Lyn M, and Aileen Ormiston. Understanding Financial Statements

Graham, Benjamin.  The Interpretation of Financial Statements.

Does your small business use accrual or cash accounting on their income statement?