The Income Statement - 6 Useful Key Terms Needed To Read The Statement Better

While the income statement itself is simple, many non-accountants lack a basic understanding of it because the terms have come to mean many things for them; that is, they aren't restricted to accounting only.

What is the Income Statement?

The income statement is a financial statement that measures the profits (or losses) of a business. It is designed to measure the results of operations during a period of time. Therefore, we can say that the income statement will tell whether a business is profitable or not.

Components of the income statement:

And we can enhance our understanding of this statement by defining with precision 6 specific terms:

1.Revenues are increases in owner's equity (capital or net worth). Revenues arise from either the performance of a service or the sale of merchandise. Examples of accounts that appear in the Revenue section are: service revenue, ticket revenue, rent revenue, and sales.

2.Other Gains and Revenues are increases in owner's equity (capital or net worth) that arise from incidental activities; that is, activities that are secondary to the main line of business. Examples: interest revenue, gain on disposal of equipment, and gain on sale of securities. We open a business with the intention of providing a service or selling merchandise--not to make money from selling old equipment or earning interest in a savings account.

3.Expenses are decreases in owner's equity (capital or net worth). Expenses --also called operating expenses-- arise in the course of generating revenues through the performance of a services or sale of merchandise. Examples of expense accounts are: rent expense, salaries expense, supplies expense, utilities expense. These accounts are easily recognized because they all share the same last name (Expense).

4.Other Expenses and Losses are also decreases in owner's equity (capital or net worth) that arise from incidental activities non-crucial to the operation of a business. Examples: Loss on disposal of equipment, and interest expense.

5.Cost Accounts --in a merchandising business-- are decreases in owner's equity that show the cost of the merchandise purchased. Examples of cost accounts are: cost of goods sold, and purchases.

6.Net Income is the excess of the revenues over the expenses. For the public and the non-accountant, net income is the profit, or as practical businessmen call it: "The bottom line." Of course, when the expenses exceed the revenues, then we have a net loss.

Many companies present their income statement in a 'single step' form, a form that summarizes the revenues and the expenses. A 'multiple-step' income statement is more detailed and informative.

The income statement is a dynamic statement, meaning that it shows the operations for a period of time. Thus, the heading will have a descriptive time line in its heading; for example: 'For the Month (Year, or Quarter) Ended August 31, 2010.'

One doesn't have to be an accountant to understand, interpret, and communicate the results that the statement presents. All it takes is a good understanding of the language presented above.

If someone asks you, "What is an income statement?" After learning the above definitions, you should be able to give a good answer with confidence and poise. Try it.