Success in accounting learning depends on the proper understanding of the basic accounting concepts, which form the basis for the theory and practice. One of the concepts to learn and understand is Income Statement, which will be described and explained further.
Income Statement is one of the three main financial statements, in addition including Balance Sheet and Cash Flow Statement. This financial statement indicates changes in the financial position of the business for a particular period of time, i.e. month, quarter or year. In this statement net profit, i.e. increase in owners’ equity, or net loss, i.e. decrease in owners’ equity is reflected for the given period.
Income Statement is related with the Balance Sheet in the terms of net result for the period, i.e. profit or loss for the period from this financial statement goes to the Balance Sheet as an increase or decrease in Retained Earnings (result not distributed to the shareholders as dividends).
Considering the structure of Income Statement, it is important that this statement indicates not only net result for the period, but also constituent parts, which make this result. So this statement will include the following:
- Revenue: amounts earned for the goods sold or services provided
- Cost of Sales: cost of goods sold or services provided. In case only goods are being sold, this items will be called Cost of Goods Sold. Here all the cost which are directly related to the revenues earned are included
- Gross Profit: difference between two mentioned items, which indicate how much business earns from the main operations
- Operating Expenses: this items consists of the expenses which cannot be directly related to the cost of goods sold or services provided. Examples can be salaries of accountants, administrative office space rent and other
- Operating Profit: difference between Gross Profit and Operating Expenses
- Interest Expenses: these expenses are shown separately to indicate financial costs the business incurs and whether it earns sufficient profit to be able to pay interest on time
- Net Profit (Loss): this is the net result for the period. If it is positive, we have a profit. If it is negative, we have a loss.
Important to notice, that Income Statement is usually prepared on the accrual basis, i.e. income and related expenses are recognized despite the fact that cash was not yet paid or received, but based on the obligation from customers to pay for goods sold or services provided and based on the obligation of the business to pay its liabilities.