Business owners, lenders and investors want to see how profitable a business performs. These people use the company’s financial statements to evaluate the profitability of the company. The income statement, one of the primary financial statements, provides the means to analyze the operation of the company during the period being reported. The company’s profit earned or loss incurred appears on the income statement. The income statement follows a basic equation format that considers revenues and expenses.
Revenues represent the money earned from customers. Businesses earn revenues by providing services, such as carpet cleaning or tutoring. Businesses also earn revenues by selling products to customers. These products consist of manufactured items or inventory purchased for resale. Whenever the company provides the product or service to the customer, it recognizes the revenue earned at that time. Revenue can be received as a cash payment or as a promise to pay in the future.
Expenses refer to the costs incurred to create items for customers, to purchase products for resale or to provide a service. These expenses include labor costs, supplies expenses or depreciation. The company recognizes these expenses when it receives the service or the items purchased. It may pay cash at the time or it may promise to pay for the item or service in the future.
The company calculates the net income using the expenses and revenues recorded during the period. The company starts by adding up all of the revenues earned. This may include revenues from various sources. For example, a company might sell equipment to its customers and additional services to install or modify the equipment. The company then adds up all of the expenses incurred. Net income equals total revenues minus total expenses.
The basic equation for the income statement can be written that total revenues minus total expenses equal net income. All income statements follow this basic format.
Variation On Basic Income Statement
While all income statements follow the same format, some include various measures of income within the body of the statement. For example, the multiple step income statement divides expenses into several categories. These include product cost expense, operating expense and other expenses. The multiple step income statement still begins with the revenues, subtracts the expenses and arrives at net income.