This post will state and define all the fundamental concepts you should know before you pick an income statement, and which you must know to be able to make sense of it. Before we talk about the different heads of the income statement, it is necessary to know what period is the income statement for. This period will most likely be for one financial year. This will always be mentioned on top of the Income Statement.
A business either sells goods to its customers or provides services to them. The considerations the business earns from providing these goods or services are summed together and presented as one numerical figure under the head of net revenue.
Cost of sales
A business incurs costs to acquire or produce the goods it sells. The cost incurred for this reason is presented under this head. It is highly likely that a business does not sell all that it buys or produces in the period of the income statement. Thus, other sub-heads such as Opening inventory, Goods Acquired or Produced and Closing Inventory. The amounts of these are stated in dollar terms. The amount of Closing Inventory is deducted from the sum of Opening Inventory and Goods Acquired or Produced to arrive at the numerical figure of the Cost of Sales. In the case where a business provides services, this head is omitted from the income statement.
The numerical figure of the Cost of Sales head is deducted from the numerical figure of the Net Revenues. A positive figure thus indicates that the business is has made a profit, while a negative figure is indicative of the fact that the business has incurred a loss. REMEMBER; this is the gross income. This means that this is not the final profit for the business, and other incomes and costs need to be adjusted to it to arrive at the net profit.
Selling, General, and Administrative Expenses
The Cost of Sales head only presents the cost of acquiring or producing the goods. However, during the normal course of operation of a business, there are a number of other expenses that are incurred. These expenses are divided into three broad categories of selling, general or administrative expenses. Selling expenses are those costs that are incurred to make sure that the sale of a product is completed. It will also include distribution costs. Administrative expenses are those which are incurred to make sure that all the operations of a business are smoothly carried out. It may include the salary of office employees. The costs which do not fall in any of these two heads are categorized as general expenses.
Gross Income less the Selling, General and Administrative Expenses is what is known as the Net Profit. This is the figure that the owner of the business can take home. It is the amount of money that is left over after covering up all the costs of the business from the revenues that the business has earned. A negative figure indicates that the business has incurred a net loss.