Whether you’re receiving income statements for your company or creating them yourself, they’re notorious as complicated and scary. But they don’t have to be. Here’s a simple guide of how to read a company’s income statement.
The Main Terms and Their Meanings
Perhaps the most daunting aspect is the terminology, but here’s the basic breakdown.
- Statement of Income, Statement of Earnings, Statement of Operations, Statement of Operating Results = Income Statement.
- P&L Statement = Profit & Loss Statement = Income Statement
- Gross = the profits before dedications
- Net = the profits after dedications
- Net Income, Net Earnings, Earnings = final profit (since Statements rarely, if ever never, use the term “profit”).
Multi-Step vs. Single-Step
Depending on the size and complexity of your business, your income statement can take two forms – multi-step, where there are more expenses and points of income calculated, and single-step, which is more refined. To see the differences and their terms, read here, but for now, let’s cover the real heart of your statement.
The Statement will begin by listing the business and the period of time the statement concerns.
Below this will be the body – where the numbers game begins. Read from top to bottom, starting with Sales Revenue and ending with Net Income, which is essentially how much money you started out with and how much is yours by the end.
Along the way, deductions will be made to cover:
Income Tax Expense.
Cost of Goods Sold (= manufacturing).
Administrative, Selling, and General Expenses (= employee wages, advertisement, legal fees, insurance premiums, etc.).
Research and Development (which made be included in the above category, depending on if you have a multi- or single-step Statement).
It’s important to note that these deductions will not be characterized by parenthesis, minuses, or any similar symbols. Instead, the Gross Income will always be followed by a deduction. After which, a strong line will separate the profit into another section, where it will be accompanied by an additional deduction. The purpose behind this is to constantly draw your eye downward to the final Net Income.
At the end, the Net Income will likely be underlined, put in bold, or have a different font type. This is why it’s called “the bottom line.”
The Real Purpose Behind Income Statements
It’s important to remember these Statements are designed to give you a very brief but very crucial insight. They will not go into detail on how broad or narrow the deductions are, or how simple or extensive your profits are.
The Most Important Part to Watch
While each line offers valuable insights, the most crucial of them all is the Cost of Goods and Sales Revenue line. This shows you how much it cost to manufacture the products sold versus how much was actually made, before further deductions are counted. Since the Cost of Goods will likely be the largest expense you have, keeping a close eye on any spikes and evaluating ways to lower this price will give you the most pleasing Net Earnings in the next statement.
The profit after the Cost of Goods deduction will be known as a Gross Margin; always watch the Gross Margin.
What is Most Commonly Grouped Together?
Income Statements often become more confusing when expenses are lumped together, but it’s a common practice to improve efficiency. The most common combination is in the Operating Costs. Rather than itemizing Administrative, Selling, and General Expenses, your Statement will likely put them into that single umbrella term.