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An Income Statement is the most important financial statement for a business. This accounting statement allows you to track revenues and expenses so you can determine the operating performance of your business over a period of time in order to determine which areas of the business are over or under budget.
At CE Thorne, CPA, because we specialize in accounting services for small businesses, preparing financial statements is one of the primary activities we do. In this article, we will explain what an income statement is, the importance of the income statement, what’s included in the income statement, and the differences between an income statement, balance sheet, and cash flow statement. After reading, you'll understand how to use the income statement to stay on top of the financial health of your business.
What is an Income Statement?
An income statement is an accounting statement that shows a complete overview of how a business is performing over a specified period of time such as a month, a quarter, or a year. It indicates where the income is coming from, the expenses incurred, and the net profit or loss during the time period.
Why is an Income Statement Important?
An income statement shows you how profitable your business has been over a given reporting period by showing your revenue, minus your expenses and losses. It is also called a “net income statement” or “profit and loss statement” (P&L). Studying your income statement allows you to hone in on specific items that are causing unexpected expenditures. Such items as cell phone use, advertising, and supply expenses can easily be tracked on the income statement. You can see when there are increases in line items like product returns or cost of goods sold as a percentage of sales. And, this statement can be used to determine income tax liability.
Small businesses need income statements and balance sheets when a bank or investor wants to see how profitable the business is. They can get a clear and accurate picture of the business’s health by showing how it is performing. When your business needs a loan, potential lenders use the income statement to determine credit limits. The income statement could be the deciding factor in whether you get a loan or not. A lender can answer the following questions based on information on the income statement:
- If there are losses, are they sustainable?
- Is the business capable of operating profitably?
- Comparing previous accounting periods, is the business growing or shrinking?
What Is Included in an Income Statement?
The income statement gives an accurate, complete picture of the state of a business by taking all revenues and subtracting all expenses from both operating and non-operating activities. It comprehensively, in a coherent and logical manner, displays the company’s revenue, costs, gross profit, selling and administrative expenses, other expenses and income, taxes paid, and net profit.
The three broad categories of information on the statement are revenues, expenses, and profits. This information uses an equation where revenues minus expenses equal profits.
These are the main components of the income statement:
- Cost of goods sold
- Gross profit
- Operating expense
- Total expenses
- Net income before taxes
- Net income
What are the Differences Between an Income Statement, a Balance Sheet, and a Cash Flow Statement?
The three primary financial statements for a business are the income statement, the balance sheet, and the cash flow statement. First, let’s look at how the income statement differs from the balance sheet.
Income Statement vs. Balance Sheet
The primary differences between an income statement and a balance sheet are in the information captured. The income statement shows the inflows and outflows of assets, where inflows are the revenues and outflows are the expenses. An excess of inflows over outflows is called net income and an excess of outflows over inflows is called a net loss. The balance sheet shows what the business owns in terms of assets, what it owes in terms of liabilities, and the difference between those two. The difference represents what the owner(s) is entitled to, called equity. Whereas the income statement uses the equation revenue minus expenses equals profits, the balance sheet uses the equation assets equal liabilities + equity. The income statement shows information for a specific period of time and the balance sheet shows information for a point in time.
Income Statement vs. Cash Flow Statement
Just as the income statement shows information for a specific period of time, so does the cash flow statement. The differences are that the cash flow statement shows the sources of a company’s cash and how that cash was spent; it does not include non-cash items such as depreciation as the income statement does. The cash flow statement is useful in determining whether the business can pay its bills from a short-term perspective. Cash flow statements should be analyzed every quarter.
Contact Our Raleigh CPA
CE Thorne CPA works for small business owners every day in preparing financial statements, analyzing them, and consulting on the health of businesses. Look at CE Thorne as your trusted partner in running your company efficiently and staying on top of its financial position. Please call us at 919-420-0092 to talk about your business and how we can help you!