Financial Statements 101: Income Statements Am I Making Money?
5 December 2016
This is part 2 of our 3 part series on financial statements.
The income statement is one of three major financial statements in which is used as a tool by business owner’s to review their financial position and health of their company (The other two statements: Balance Sheet; and Statement of Cash Flows). Financial position is assessed in the income statement by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities. Also known as the profit and loss statement (P&L) or statement of operations, the income statement is a breakout of the revenues and expenses of all business operations. Unlike the balance sheet, which covers one moment in time, the income statement provides performance information over a specific period of time. The time period covered is usually for a month, quarter, or year and the statement typically provides two to three years of historical data for comparison.
Generally the income statement begins with sales and works down to net income. For presentation purposes, the income statement is divided into two parts: operating and non-operating. The operating portion of the income statement discloses information about revenues and expenses that are a direct result of regular business operations. The non-operating section discloses revenue and expense information about activities that are not directly tied to a company's regular operations. To understand operating vs. non-operating in greater detail, assume that a business that sells bicycles will generate revenues through the sales and expenses of manufacturing bicycles- these revenues and expenses would be operating. If the bicycle company sold part of their manufacturing plant, any gain or expenses attributed to the sale would be considered non-operating.
The income statement can also be shown in two different formats: Single-step and Multiple-step. The difference in formats have to do with the number of subtractions and subtotals that appear on the income statement before getting to the company's bottom line of net income.
The report is simple in nature and outlines a basic equation: Revenues- Expenses = Net Income. The single-step income statement format uses a single subtotal for all revenue line items and a single subtotal for all expense line items, with a net gain or loss appearing at the bottom of the report. The format does not specifically itemize for operating and non-operating line items. It is most commonly used by businesses that have relatively simple operations.
The multiple-step profit and loss statement segregates the operating revenues and operating expenses from the nonoperating revenues, nonoperating expenses, gains, and losses. The multiple-step income statement also shows the gross profit, which is a performance measurement used by many companies to identify efficiencies in their business. Contrary from the single-step format, the multiple-step format is a more complex statement that also arrives to net income:
Operating revenue - operating expenses attributable to cost of goods sold = Gross Profit - operating expenses attributable to selling, general and administrative expenses = Operating Income + Non-operating Income - Non-operating expenses = Net Income.
A business owner would prefer the multiple-step format for a couple of reasons:
- Gross profit assesses a company's efficiency at using labor and supplies. The metric only considers variable costs, such as costs that fluctuate with the level of output. Gross profit can be used to calculate the gross profit margin, which is useful for comparing a company's production efficiency over time.
- The multiple-step process breaks out how revenue and expenses are allocated in operating and non-operating activities. It is important for business owners to distinguish which operating and non-operating activities are affecting the bottom line of net income.
As always, please reach out to the team at GMAC Accounting if you have any questions about the Income Statement or any other financial report.
This article is brought to you by GMAC Accounting, LLC, a full service cloud accounting and bookkeeping firm. With over 30 years of experience in the business of banking, accounting and project management, GMAC assists small and mid-sized businesses with all their financial needs. For more information on GMAC Accounting, please visit: www.GMACAccounting.com