Financial Statements 101 - The Income Statement

Simply put, the income statement is all income minus all expenses and it reflects your company's net income or loss.

The key parts to this statement include:

• Sales or revenues
• Cost of goods sold
• Expenses
• Net income or loss

Cost of goods sold or COGS is comprised of all the company costs to produce or purchase the goods it sold. Expenses include all expenses involved in operating a business to support the sales process. This can include advertising, administration costs, rent, salaries, etc.

One of the important distinctions between the income statement and the cash flow statement, which I'll cover later, is that sales are realized on an accrual basis, meaning - the sale in the income statement is realized the month the sale occurs not when the cash is received. So, for example, a sale that occurs in January but is purchased on a 60 day credit terms from a customer is recorded on the income statement in January but on the cash flow statement it shows up in March. The same goes for payables - an Accounts Payable is recorded the month it occurs versus the month it is paid.

Additionally, when it comes to mortgage or loan payments, only the interest or operating portion is shown in the income statement versus both the principal and interest in the cash flow statement.

COGS

"In financial accounting, cost of goods sold (COGS) includes the direct costs attributable to the production of the goods sold by a company. This amount includes the materials cost used in creating the goods along with the direct labor costs used to produce the good. It excludes indirect expenses such as distribution costs and sales force costs." - Wikipedia

In a hamburger stand business, COGS would include the cost of the ground beef, the buns, the pickles as well as the labor cost that goes into making the hamburgers. Example: If Phil works the register for 4 hours and makes hamburgers for 4 hours and he is paid $10 an hour, then $40 of his labor goes into your COGS for the day.

Expenses

Advertising and promotion: TV, radio, Google Adwords, print ads, etc. Promotion includes product giveaways, name identification on a sports stadium, charitable events, etc.

Other selling administration expenses: This is a catchall for any selling expenses; salespeople's and sales managers' salaries, commissions, bonuses and other compensation expenses. The cost of sales offices and any expenses related to those offices would fall in this category.

Other operating expenses: This includes items such as general office needs, royalties, research and product development.

Interest Expenses: Expenses paid for interest on long or short term debt are shown here.

Depreciation and Amortization: Depreciation on buildings, machinery, or other items, as well as amortization on intangible items are shown in this line item.

Insurance Expenses: theft, fire, other losses life insurance, etc.

Taxes: Ye olde income taxes go here.

Other Expenses: Any expenses that don't fit into one of the other categories go here.

EBITDA

This is Earnings Before Interest, Taxes, Depreciation and Amortization. This figure is used for analysis sake because it eliminates the effects of the company's activities to raise cash outside their operating activities. It also eliminates accounting decisions that could impact the bottom line such as the company's policies relating to depreciation.

Net Profit or Loss

The bottom line of any income statement is the net profit or loss but this line can mean very little if you do not understand the preceding lines that go into the make-up of this number.

To see an example of an income statement, click here.