The basic guide to an income statement

Of the three main financial reports, the income statement is typically the best understood. After all, it shows your business’s bottom line so it’s of most interest.  Sometimes called the profit and loss statement, or P&L for short, you will see variations in the amount of detail presented, order of expenses, terms used but the basic structure of every income statement is exactly the same and consists of:

  • revenue
  • cost of sales
  • expenses
  • other expenses
  • income tax
  • net income (loss)

Most components of the income statement are self-explanatory but a few could use a little explanation so they’ll be examined a bit further.

What exactly is included in cost of sales?

Cost of sales (sometimes referred to as cost of goods sold) are the expenses that exist because a sale took place.  They are directly related to the good or service that was sold and may include direct labour, direct materials, and an allocation of overhead.  The exact costs will differ from one business to another so let’s look at a few examples.  A travel agency would include commissions paid to consultants and royalty fees paid to a franchisor as cost of sales.  For a bakery, cost of sales would consist of supplies and direct wages.  An interior designer would include the cost of products/accessories purchased and direct wages.  For a consultant, the cost of sales is simply direct wages (and any costs associated with presentations, research, reports, etc.).

What is the difference between expenses and other expenses?  

Expenses are divided between operating and non-operating.  Operating expenses are the costs of running your business, incurred as part of normal business activities.  Examples are rent, bank fees, insurance, advertising, professional development, dues & fees, utilities, wages & benefits, office supplies, phone, meals & entertainment.  Non-operating expenses are those considered to be outside typical operations.  Common examples are interest and foreign exchange gain/loss. It’s important to distinguish between operating and non-operating expenses in order to accurately assess the actual performance of your business.

While the income statement is useful for telling you the financial results of your business, it doesn’t report on it’s financial condition.  The balance sheet provides that information and will be featured next in the series.

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