How do you read an Income Statement?

Definition

An Income Statement is a period report that starts with revenue and subtracts costs and expenses. On the books, this is the P&L, and the bottom line is net income or a net loss.

Revenue sits at the top, and costs and expenses come next. What remains after those lines is profit, or a loss.

The period is the whole point. A March Income Statement covers March, not a single day.

If you keep accrual books, you record revenue when you earn it and expenses when you incur them. Cash-basis P&Ls mostly follow when money moved.

Where it shows up

Balance Sheet: Related to net income that flows into retained earnings.

P&L: Located as the period summary of revenue and expenses, ending in profit or loss.

Cash flow: Related to profit before working-capital and financing adjustments.

See also: Revenue · Operating Expenses · Net Income

When you look at your reports, the Income Statement is the one that covers a stretch of time. You will also hear it called a P&L, a profit and loss statement, or an earnings statement.

A high revenue line is not automatically a good month. If rent, payroll, and supplies ate the same amount, net income can still be near zero.

The Balance Sheet does not list sales and rent as lines. The period's net income still lands there, because it is added to retained earnings in equity.

On the Statement of Cash Flows, net income is often the starting point. Profit is then adjusted for items that did not move cash, and for changes in receivables, inventory, and payables.

Many small-business packs print this month next to last month, or this month next to the budget. That comparison is still the same P&L, just with extra columns.

How it works

A typical month starts with revenue. You teach classes, sell goods, or finish a job, and you record the amount earned.

Direct costs of what you sold sit under revenue as cost of goods sold. Subtract that, and you have gross profit.

Operating expenses come next. Rent, payroll, software, and insurance usually live here.

Operating income is profit from the core work before interest and taxes. Net income is what remains after those last items too.

At month-end you close the income accounts so they start the next period at zero. The net amount moves to retained earnings on the Balance Sheet.

The accounting period is the span you chose to measure. A month, a quarter, and a year can each have their own Income Statement.

Example

A neighborhood yoga studio bills $12,000 of classes in March. Rent is $3,000, instructor payroll is $5,000, and supplies are $500.

Class revenue is recorded as it is earned:

Debit: Cash $12,000

Credit: Class revenue $12,000

Cash and revenue both go up by $12,000. That $12,000 is the top of the March P&L.

Rent, payroll, and supplies then hit expense accounts for $8,500 in total. March net income is $3,500, which is $12,000 minus $8,500.

The Balance Sheet does not show the $12,000 of classes as its own line. After the close, the $3,500 of profit sits in retained earnings.

If $2,000 of those classes had been invoiced instead of collected, revenue would still be $12,000. Only the cash and accounts receivable lines on the snapshot would look different.

Common mix-ups

An Income Statement is not a Balance Sheet. This report covers a period; the Balance Sheet is one date.

Profit is not cash. The studio can show $3,500 of net income and still be tight if members have not paid, or if it just prepaid a quarter of rent.

Revenue is not net income. Revenue is the top; net income is what is left after costs and expenses.

Related terms

• Revenue: The total value of goods and services the business earned in a period.
• Cost Of Goods Sold: The direct cost of the products sold during the period.
• Gross Profit: Revenue minus the direct cost of delivering it.
• Operating Expenses: The ongoing costs of running the business that are not direct costs of sale.
• Operating Income: Profit from core operations before interest and taxes.
• Net Income: What is left from revenue after every expense, including interest and taxes, is subtracted.
• Accounting Period: The span of time a set of financial statements covers.
• Financial Statement Package: The bundled set of statements and schedules delivered after a close.