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The Income Statement

Posted by Seth Elliott On September - 14 - 2010

Continuing our discussion of key accounting and finance elements for entrepreneurs, let’s take a look at the components of a financial statement. It’s easiest to begin by examining the Income Statement.

The Income Statement is what many people imagine when thinking of financial statements. Essentially, the Income Statement is the Profit and Loss statement (P&L) of a business. As such, the Income Statement consists of the following primary components:

Revenue

Cost of Goods

Gross Margin

General & Administrative Expenses

Sales & Marketing Expenses

Operating Income

Interest

Taxes

Net Income

Let’s examine each of these components briefly.

Revenues. Revenue represents payments made to a firm in exchange for the provision of goods or services. Revenue is essentially the same as sales, so you may occasionally see it listed as such. Occasionally you may see it listed as net sales, which represents revenues that have been already adjusted for discounts and returns. Remember that many companies use the accrual method of accounting,
so revenues are not generally a reflection of actual cash received for goods or services.

Cost of Goods. Cost of Goods refers to the cost of goods sold – the actual amounts paid for any products that your firm then sells. This can also be referred to cost of sales (particularly when services are offered). Cost of Goods should be tied directly to the production of an item and only listed upon its sale.

Gross Margin. Gross Margin is simply the difference between Revenues and Cost of Goods. Gross Margin is often compared to competitors in an industry to determine the strength or efficiency of an enterprise.

General & Administrative Expenses. This line item covers most of the day-to-day expenses required to operate the business. These expenses include salaries and payroll taxes, rents, legal, utilities, depreciation, franchise taxes, license fees, telecommunications, and other similar items.

Sales & Marketing Traditionally, expenses are termed SG&A (Sales, General and Administrative). It’s worth noting that the expenses tied to selling (and marketing) your product and service are often separately highlighted.

Operating Income. Operating Income (or loss) is the net of Revenues less Cost of Goods less Sales, General and Administrative Expenses. Operating Income is sometimes referred to as operating profit. It can sometimes be used as a proxy for EBIT or EBITDA (which we will discuss in detail in our next post). It is important to remember that due to the nuances of accrual accounting, operating income is not the same as cash flow.

Interest. Interest usually references the cost of borrowed money (debt incurred by the company). It can also be additive if your firm has funds invested and earns interest on those.

Taxes. Taxes are variable dependent upon how a firm treats taxes and whether there are any deferments. In all cases, this line item references income taxes (state, federal or local). Most other taxes (payroll, franchise, etc.) are captured in General & Administrative Expenses.

Net Income. This is a company’s bottom line – often referred to as profit. It’s simply what is left after all costs of sales and expenses have been accounted for. Once again, remember that
Net Income is not the same as cash flow.

As I’ve referenced, it is important to remember that there is a significant difference between the Income Statement and the actual cash profit generated by a business. A number of nuances associated with accrual accounting methods allow for this. In the next post, we will examine these elements, as well as addressing the concepts of EBIT and EBITDA.

You may wish to review other posts in this series:

Corporate Finance and the Entrepreneur

Leaping the GAAP

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About the Author

I have spent the last 15 years advising entrepreneurs on starting and growing their businesses, as well as assisting in financing those growth efforts. I have also been an entrepreneur on several occasions myself. By writing this blog, I hope to provide actionable advice on how to achieve your goals and become more successful.