So, last time we looked at the Balance Sheet and went into detail about what it’s made up of. Wasn’t so bad, right? Never mind, don’t answer that. This week, I promise I’ll try to make it a little more exciting—so cancel all your plans and settle in for another session of Decoding Accounting Terms!
Today, we will be learning about the Income Statement, a financial statement just like the Balance Sheet. However, they do have some major differences; a Balance Sheet is made up of assets and liabilities, whereas an Income Statement is made up of income and expenses.
What is an Income Statement?
An Income Statement, also known as a Profit and Loss report, shows you whether or not your business is making money. The basic formula is Total Income – Total Expenses = Net Income. But keep in mind that the numbers shown in your Income Statement do not include any taxes you may have collected or paid.
Before we start, it’s important to know about income and expense accounts. Let me break that down for you.
Money comes into your business and needs to be organized. For instance, if your business has multiple sources of income, it would be best to create separate income accounts for each source so they’re easily trackable and distinguishable. If you haven’t noticed already, accounting relies heavily on accurate recording. It may seem like a lot of work, but trust me, it pays off in the insight your accounting efforts will give you.
Money goes out to pay the bills. Just like the income accounts, there are many expense accounts so we need to be careful and use the right one depending on the transaction. Below you’ll find a few different expense accounts defined along with a couple good reasons to use them. Basically, it’s to help you categorize your expenses so they’re not all in one account. Reason being, if you need to make budget cuts, you’ll know where to look. Personally, I need to cut down on food (Ex. Meals and Entertainment Expense).
Alright, let’s get into it!
Say you’re selling socks (yeah, I might be looking at my socks right now) and you sell $100,000 (before tax) worth of socks in a year. That amount would go under your sales income account. $100,000 isn’t your true profit because don’t forget, there are expenses to running a business.
As I mentioned before, the list of expense accounts can go on and on. The first expense we will look at is Cost of Goods Sold (COGS). The name says it all, COGS is the amount you spent to purchase the goods you plan to sell. In this case let’s say your COGS is $20,000. Next up, let’s say you’re operating from an office space, and since there’s no such thing as free lunch, your rent expense is $30,000. To keep it simple, let’s just say those are all the expenses you have for the year.
Now it’s time to do some more calculations. Your sales for the year total $100,000, minus $50,000 for your expenses, which would equal $50,000 in net income (profit, yay!). If things were reversed and you only sold $50,000 worth of socks but your expenses were $100,000—$50,000 would be your net income (loss).
As we’ve mentioned in our What Your Accountant Won’t Tell You series, having an up-to-date and accurate Income Statement can shed light on many aspects of your business. From promotion success to employee bonus valuation—your Income Statement provides critical information that even your accountant can’t.
Also, remember that the Profit and Loss report is basically the same as the Income Statement. Accounting terms change so often so it can get a bit confusing if you’re not keeping up. At a quick glance, all the financial statements may seem alike but I can assure you they all serve their own purpose. Accounting may be repetitive but there is a reason for that, YOU DO NOT WANT TO MAKE A MISTAKE!
It’s always better to get it done correctly the first time around rather than having to work backwards to find where it went wrong. Believe me, that task is WAY less fun. Luckily, with an accounting software like Kashoo, all your work is automated so you can manage your financials stress-free! Sign up for our free 14-day trial and see just how easy it is to create your own Income Statement using Kashoo.
(I’m sorry, I was only kidding when I said this post would be more exciting.)
Thanks for reading!