What is an income statement?An income statement, also known as a profit and loss statement (P&L), is one of several key financial statements that small business owners, accountants, and the self-employed use to assess their company’s financial performance.The income statement — along with the balance sheet and the cash flow statement — summarizes a company’s profitability for the year. It shows income through a particular period of time, which may read something like, “for the fiscal year or quarter ending [date].”The time period is determined by the company and will vary. For example, it could be:
Relationship to cash flowIf you’re using the accrual method, your statement of cash flows will not directly connect to activity in your company’s income statement. The accrual method of accounting posts revenue and expenses, regardless of when cash moves in or out of the business.Using the baseball bat example above, Sterling Sporting Goods posts $6,000 in revenue in March, even if none of the $6,000 is received in cash. The $6,000 is posted in accounts receivable, which is the money due to a company for goods or services delivered but not yet paid for by the customer.In March, the revenue from the sale of baseball bats is matched with the expense of purchasing inventory, and a $1,000 profit is recorded. When cash is received, Sterling reduces the accounts receivable account and increases cash or total revenue from the sale.Connection to the balance sheetA company’s balance sheet is a snapshot of a company’s net worth at any given time. A company’s net income on the income statement will also be posted to the equity section of the balance sheet. The balance sheet formula is:Assets = Liabilities + EquityThe connection between Sterling Sporting Goods’ balance sheet and its income statement looks like this:At the end of each accounting period (month and year), Sterling closes the books by adjusting all revenue and expense accounts to zero. The company’s total revenue minus expenses is posted to net income, and net income increases the equity balance on the balance sheet.The $1,000 profit (net income) from March bat sales increases Sterling’s equity. Bear in mind that income statement accounts begin each new period with a zero balance, while the balance sheet amounts are carried forward from one year to the next.Operating vs. non-operating incomeThe income statement formula is used to produce a single-step income statement, which is perfectly acceptable for many companies. However, many tax accountants and some banks analyze business results using a multiple-step income statement since it provides more detail.A multiple-step income statement separates operating income and expenses from non-operating activity. Operating income and expenses are transactions related to the day-to-day operations of the business. Non-operating activity includes things like gains or losses from investments, sales of property or assets, etc.
- For the three months ending December 31, 2019 (October 1-December 31, 2019)
- For the four weeks ending December 27, 2019 (November 29-December 27, 2019)
- For the fiscal year ending June 30, 2020 (July 1, 2019-June 30, 2020)
How to calculate both operating and non-operating incomeSterling Sporting Goods, for example, is in the business of selling sporting goods equipment through its retail locations. If, on the other hand, the company sells a building, resulting in a capital gain, the gain is considered non-operating income.To put it another way, Sterling Sporting Goods wants to take out a business loan and must show the company’s operating income to its creditors.The company pulls up its accounting software and learns that the company’s revenue was $250,000 last year.The company reported the following expenses:
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- Cost of goods sold (COGS): $15,000.
- Improvements to property: $5,000.
- Utilities: $4,000
- Wages: $65,000
- Office supplies: $3,500
- Insurance: $7,500