Income Statements

While the balance sheet is a financial snapshot, giving you a picture of the business's assets and liabilities on a single day at the end of the accounting period, the income statement shows you a summary of the flow of transactions your business has had over the entire accounting period. In other words, the income statement shows you what happened during the period between balance sheets.

The income statement, also referred to as a "profit and loss statement," "statement of incomes and losses," or "report of earnings," tells you or your investors:

Three years' worth of income-statement data are normally presented, so that you can make comparisons and identify trends. The data consists of the following types of items:

A typical income statement showing three years' information is presented below.

Smith Manufacturing Company
Income Statement
Years Ended December 31, 200Z, 200Y, and 200X

200Z 200Y 200X
Sales $X $X $X
(Sales returns and allowances) (X) (X) (X)
Net sales $X $X $X
Cost of goods sold
Beginning inventory X X X
Cost of goods purchased X X X
(Ending inventory) (X) (X) (X)
Cost of goods sold $X $X $X
Gross profit $X $X $X
Selling expense ($X) ($X) ($X)
General and administrative expense (X) (X) (X)
Total operating expenses $X $X $X
Income from operations $X $X $X
Interest expense $X $X $X
Pretax income X X X
Income taxes (X) (X) (X)
Net income ($X) ($X) ($X)
(The notes are an integral part of this statement.)

Using the income statement. As with the balance sheet, an in-depth knowledge of accounting is not necessary for you to make good use of the income statement data.

For example, you can use your income statement to determine sales trends. Are sales going up or down, or are they holding steady? If they're going up, are they going up at the rate you want or expect? Also, if you sell goods, you can use the income statement to monitor quality control. Look at your sales returns and allowances. If that number is rising, it may indicate that you have a problem with product quality.

Gross profit margin should be closely monitored to make sure that your business is operating at the same profitability levels as it grows. To find this margin, divide your gross profit (sales minus cost of goods sold) by your sales for each of the years covered by the income statement. If the percentage is going down, it may indicate that you need to try to raise prices.

Also, check out your selling expense. It should increase only in proportion to increases in sales. Disproportionate increases in selling expense should be followed up and corrected.

General and administrative expenses should also be closely watched. Increases in this area may mean that the company is getting too bureaucratic and is in line for some cost-cutting measures, or that equipment maintenance is too expensive and new equipment should be considered.

Interest expense is an important measure of how your company is doing. If your interest expense is increasing rapidly as a percentage of sales or net income, you may be in the process of becoming overburdened with debt.