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What Is an Income Statement?

Income statements show how profitable a business is, and – along with balance sheets and cash flow statements – are one of the three most important documents in financial accounting. You may have heard them referred to as “net income statements” or “statements of earnings.” When used for internal purposes only, an income statement may be referred to as a “profit and loss” statement.

In addition to providing businesses with a snapshot of net income over a defined length of time, the Australian Securities and Investments Commission (ASIC) requires financial reporting of companies operating in Australia, usually on an annual basis. Income statements are also important when dealing with banks and investors as they can be used to predict future business performance.

What is income?

In order to prepare an income statement, it’s important to understand the concept of income in a business setting. This may sound like a silly concept, as many of us think of income as simply money earned. However, in broader terms, income is money that comes into a business from a variety of sources.

So, what is income exactly? Businesses acquire income from revenue and gains. Revenue comes from primary business activities, or operating revenue, such as sales. It also comes from secondary business activities, or non-operating revenue, from royalties or interest payments. Money also comes into a business from non-business activities, or gains. An example of a gain could be the sale of an asset.

Understanding net income

Net income is calculated by subtracting the sum of a business’s total revenue and gains from the sum of its total expenses and losses:

Net Income = (Total Revenue + Gains) – (Total Expenses + Losses)

Expenses and losses include primary and secondary activity expenses and such as:

  • cost of goods sold (COGS)

  • selling, general, and administrative expenses (SG&A)

  • marketing, advertising, and promotion expenses

  • depreciation and amortization expenses

  • research and development (R&D)

  • income taxes

  • interest

As you can see, before you get to work on your income statement, you’ll need to gather some data on the financial activity of your business. It could be helpful to use an accounting journal to ease this process.

How to prepare an income statement

Income statement format may vary from business to business, however, all income statements contain the same basic information, as described above. The kinds of revenue and expenses may differ according to the type and size of a business enterprise.

Once you have collected the data on your business revenue and expenses, an income statement example can come in handy. In fact, actual income statements from the world’s largest companies can be found online as well as sample statements for mid-sized and small, local businesses. Check out a variety of examples and choose the income statement format that best matches your company profile. Excel gurus may want to then create a template tailored for their business. Use formatting features like colour-coding, bold, underling and indentation to differentiate data. Free templates abound, too, so no need to reinvent the wheel if spreadsheets aren’t your thing.

After inputting your data, analyse your income statement to make savvy business decisions in the short term or integrate it into a financial model to forecast business performance in years to come.

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