Income statements are a key financial document that indicate how much net profit your company earned. Understanding them is key to knowing when your firm is in the black versus the red, and is essential when maintaining strong habits in accounting and bookkeeping. Here is how they work:
An income statement is a financial statement that summarizes a businesses profit and loss over a period of time (hence why it is also called a Profit and Loss Statement, or PnL). An income statement has three main section:
Revenue: money coming in
Expenses: money going out
Net Income: Revenue - Expenses
Let’s see this in action.
1. Revenue
Anything that you make money from core business activities. Simply put, money made from selling your product or service to customers.
2. Expenses
Expenses will change between businesses, but here are a few key ones to keep in mind:
Cost of Goods or Services (COGS): The direct cost of producing your goods or service. This includes raw materials, direct labor, and factory overhead, just to name a few.
Operational Expenses (OPEX): this is all the indirect costs of running your business. This often gets broken down into a few different categories.
General and Administrative Costs: Rent, utilities, salaries (non-production), advertising, office supplies, etc.
Depreciation and Amortization: Spreading the cost of long term assets over its lifespan
Research and Development: Cost of innovation and new product development
Non-Operating Expenses: costs not associated with core operations
Interest Expense
Income Taxes
Here is our original PnL categorized by spending type, color-coded accordingly:
Note: Maintenance, Salaries, and Utilities would be part of COGS if it was involved in manufacturing (since it relates to creating the product/service), and would be part of OPEX for all other parts of the business.
3. Net Profits
Subtract expenses from revenue.
Key Financial Metric: EBITDA
EBITDA, or Earnings Before Interest, Tax, Depreciation, and Amortization, is an important metric that captures a firm's core operational profitability. It strips out tax, accounting, and financing, which can cloud the company’s core functions within an income statement. Simply subtract out the categories mentioned above from revenue to get this metric.
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