Understanding Income Statements – Revenue and Expenses

Income statements focus on revenue and expenses in your business. Income statements are generally run for a given period, such as a month, quarter or year.

Income statements are particularly valuable tool to monitor your company’s operational health. They allow you, financial institutions, and potential investors to get a sense of whether your products and services perform well, roughly the same as the competition and the industry average, or underperform.

Is your revenue rising year over year and quarter over quarter, or staying relatively the same or dropping? If the latter, the financial statements can help you determine what the issue is. Have your COGS risen above prior levels? Have operating costs? If so, can you return to robust profitability by cutting COGS or raising pricing? You can also monitor the seasonality of revenues and costs.

Finally, if you’d like to expand your business, you can make a decision about whether your profits are robust enough to do so. Income statements can also give a sense of whether your operations are efficient and provide insights about its operations.

Income statements usually start with revenue and any gains. The main categories are:

• Operating revenue: Revenue from your main activities and products.
• Other income (Gains): Money realized from non-business activity, such as the sale of an asset or interest from company’s bank account.

Following revenue and gains, income statements set forth the expenses and losses. The main categories are:

• Cost of Goods Sold (COGS): Any cost incurred in earning the business’s operating revenue, such as cost of inventory/material sold and related delivery charges, direct sales persons’ salary, or cost of acquiring the customer (such as referral fees).
• Operating expenses: Any cost incurred in connection with running the business, but not directly related to revenue earning activities. Common examples include rent, office supplies, utilities, office manager’s salary, general repair and maintenance.
• Other expenses (Losses): Business expenses incurred, but not in connection with running the business, such as the interest on loans or loss from the sales of asset.

After these categories are delineated, some income statements show the gross profit (also known as gross profit margin), which is arrived at using the following equation:

Revenue – COGS = Gross Profit

Both financial institutions and potential investors examine gross profit/gross profit margins because they show how healthy your revenues are against the cost of producing the revenue.

Next, income statements show net income categories. Net income is arrived at using the following equation:

Gross Profit – Operating Expenses = Net Income

Many income statements delineate the net income before taxes, which is arrived at via the following equation:

(Revenue + Other Income (Gains)) – (Expenses + Other Expenses (Losses)) = Net Income Before Taxes

Then, the amount of tax appears on the income statement, followed by the net income after taxes. Therefore, the “net income after taxes” line is the literal bottom line on many income statements. It’s the single most important figure telling you — and everyone else reading the income statement — whether your small business is profitable or not.

If your company has shareholders, the net income after taxes is divided by the number of outstanding shareholders to arrive at earnings per share.