An Income Statement is one of three major financial reports that every business should create or run monthly to get an accurate picture of how the business is performing. (The other two statements are the Balance Sheet and the Cash Flow statement.) The components of the Income Statement are different from those found on the Balance Sheet, while the Cash Flow report incorporates accounts from both the Income Statement and the Balance Sheet. One question that I often get is, “why am I not seeing all my accounts on the Income Statement?” The short answer is that some of the accounts are likely sitting on the Balance Sheet because they are classified as assets, liabilities, or equity accounts. So, then what are the accounts that show up on the Income Statement? The answer is income (or revenue or sales – all referring to the same concept, just with different names) and expenses. Let’s take a brief look at both of these account categories.
Income:
Income mainly refers to the increase in cash your business brings in by providing services or selling products or through receiving donations, grants, insurance claim payments, etc. Income is often broken out into two groups:
- Sales or revenue and
- Other income.
The former is normally the first category on any income statement, while Other Income is often the last category, along with Other Expenses, on the income statement. Sales and revenue are created by your business providing something – services or products – to a third party. This income category also consists of any adjustments to your income—for example, discounts and refunds given to clients and tips received from clients.
The second income category – Other Income, is revenue obtained without your business providing any service or product in return. This includes grants, donations (mainly to non-profits), insurance claims received, cash rewards from credit cards, gains from the sale of assets, and other similar sources.
Expenses:
Expenses are the opposite of income. These are funds spent to run your business. Think of payroll, utilities, insurance, legal services, etc. Three main expense breakouts appear on the Income Statement:
- Cost of Sales (or Cost of Goods Sold),
- Operating expenses, and
- Other Expenses.
Cost of Sales (COS) is used by companies that sell services, while Cost of Goods Sold (COGS) is used by businesses that sell products. Both COS and COGS include all expenses that are directly tied to what your business sells. For example, if your business sells pencils, the materials used to make the pencils, the labor paid to factory workers, and the overhead expenses that directly impact production (e.g., electricity used by the factory) are all part of the COGS expenses.
Operating expenses are all expenses used in operating your business that are not part of the COS or COGS. Examples include utilities, payroll, shipping costs, and office supplies.
Other Expenses are just that, namely any expenses that the business incurs that do not fit the other two categories. Examples include: depreciation expense, interest payments on loans, and loss on the sale of assets or inventory.
The final part of the Income Statement is the sum of the income and the expenses, which is called “Net Income,” if total income is more than total expenses, or “Net Loss,” if total income is less than total expenses. Ensuring that every account is properly categorized is crucial for any business since it uses the results from the Income Statement in making operational decisions. Due to the complexity of drafting an Income Statement, I strongly recommend seeking the advice and assistance of an accountant when setting up an income statement template.
DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting, or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.
