A complete no geek-speak explanation of your Income Statement in Three Parts
Every Income Statement tells its own Story
and that story can be incredibly useful for improving your business and making more profit
For Aussies, at tax time, you had over your books to your accountant, they do some “magic”, and the you sign-of on it all that you agree with whatever “magic” has been performed.
You might think that all you need to look at is the very bottom number and how much tax is payable, but actually all income statements, when well prepared, tell their own story – you just need to be able to hear the narrative and understand what it is relating to you.
The Profit and Loss report was invented to enable informed decision making; – it is a standardised information source used to assess outcomes and thereby guide actions. Listing out a whole lot of revenues and expenses and then coming up with a total at the bottom is great for calculating taxes; but to make understanding the story of what happened simpler, most are multi-layered. What this means is they include sub-totals and totals through-out the report. Think of it as sub-sections that add together to create a whole.
This year, instead of simply signing the paperwork and paying the tax, arm yourself with some extra knowledge and use that information to your profitable advantage.
There are Three Steps to mastering your Income Statement once and for all;
- Step 1: Master the Accounting Conventions
- Step 2: Master The Elements – Conventional Headings Explained
- Step 3: Master the Format – Conventional Layout Explained
Income Statements Explained – Conventions Mastered – Step 1
Accounting is simply a mix of Jargon and Convention – don’t get too hung up about that because after 800 years it is pretty much still exactly the same as when it started. The fact it has lasted pretty much unchanged for all that time does pay some testament to the fact it is actually very very useful.
There are those who argue that is time for an overhaul, and it may well be; but as the most enduring and entrenched form of reporting, used globally and across language barriers change happen at a glacial rate. For more about how to get around the wording see How to cut through financial jargon forever…
Here the same is also true – simply learn a few words and rules and your favourite business will benefit!Cricket is also a mix of jargon and convention, as is Football, netball and pretty well all sports; – everyone gets their heads around dealing with “dumb” rules all the time in order to follow their favourite team.
A bit of boring background – don’t skip this bit it might be boring but it is also fundamental:
Income Statements (also known as a Profit and Loss Statement) give a report on the trading history of a business – they records all the “INs and OUTs” over a period of time:
• Incomings are “Ins” – Revenues, Sales, Turnover, Interest, Royalties, Licence Fees, Grants, Foreign Exchange Gains, Subsidies, Gifts etc.
• Outgoings are “Outs” – Expenses such as Materials, Staff, Rent, Taxes etc.
This history can be reported to show the story of a week, a month, or a year of activity. In other words the major aim of an Income Statement is to summarise, for a given period of time, the revenue received against the related expenses that the company had to spend.
Now take the next steps and start to personalise it for your own business (not just the tax-man)
3 ways your Profit and Loss can Serve you Better[/box]
How an income Statement is laid out is dictated by convention – they are all much the same so they can all be compared; with each other, between companies, between years etc. etc. However whilst convention is used it is not dictatorial and consequently there are innumerable variations of the convention.
For the purposes of these musings I stick to the following definitions, I am usually quite strict and consistent, but even I catch myself occasionally using terms interchangeable – all of these words tend to be used randomly to indicate MONEY in some for or other, so don’t be alarmed if you discover you own business’s Income Statement strays from these.
That said, the benefit of using these terms specifically is that it enables your story to become clearer and the clearer the message the easier it is to decide how to make more profitable progress.
Staying mindful of the type of business in front of you will help you retain context and better understand the specific story that Income Statement is telling.
Income v Revenue
Income is money earned by the business in the course of undertaking the day-to-day normal business activities
Revenue is money allocated to the business activities undertaken within a reporting period.
Income may not always be monetary but Revenues always are – Thing for example about the value of the land, a patent, or a trademark a business owns – it may be increasing year on year, and this increase in value is income to the business, but unlikely to be recognised as revenue on the Income statement until the asset is sold.
Costs v Expenses
Costs are money used up by the business in the course of undertaking the day-to-day normal business activities
Expenses are costs allocated to the business activities undertaken within a reporting period.
Costs may not always be monetary but Expenses always are – the case of opportunity costs; which is the lost value forgone when you choose to do one thing over another, this cost never appears on your Income Statement but can be very real. If you have to choose between a holiday in New Delhi or New York each offer a different experience and if you choose New Delhi, then your opportunity cost was missing out on the New York experiences.
So, the two main elements of an Income Statement are the Revenues and Expenses because an Income Statement is a report of activity that always relates to a period of time.
Every Income Statement exists to enable informed decision making – it is an information source used to assess outcomes and thereby guide actions. Adding all the revenues and then expenses and to come up with a total at the bottom of the page is great for calculating taxes; but to make understanding the story of what happened simpler, to monitor and adjust progress, most Income Statements are multi-layered. What this means is they include sub-totals and totals through-out the report. Think of it as sub-sections that add together to create a whole. These sub-sections are also governed by convention; they must be listed in a specific order so that not only the business Profit can be calculated easily, but the quality of management’s performance is also apparent.
The next two Steps are covered in the following articles:
All the details on what the breakups of each Revenue and Expense Heading means, and how the categories are important for driving better management decisions.
To make understanding the story of what happened simpler, most income statements are multi-layered. What this means is they include sub-totals and totals through-out the report – find out why each sub-total and total has a reason how it is important.
Your Feedback is Welcome
If I haven’t quite explained something clearly enough – please post your question in the comments/reply section and I will endeavour to clarify it for everyone.
P.S. – if anyone can explain to me why Income/Revenue is singular and Costs/Expenses are plural – I would love to know!