4 Revenue and Expenses
Income Statement Fundamentals
Jacqueline Gagnon
Let’s look at a sample multi-step income statement for a company. There are no amounts here, and the math calculations are written in brackets: (+), (-), and (=). You can use this for reference when completing practice problems, and you may want to print and memorize the format.
| Sample Company Income Statement (Multi-Step Format) |
||
|---|---|---|
| Sales | ||
| ( – ) Cost of Goods Sold | ||
| ( = ) Gross Profit | ||
| Operating Expenses: | ||
| ( – ) Bad Debt Expense | ||
| ( – ) Depreciation Expense | ||
| ( – ) Freight & Shipping Expense | ||
| ( – ) Office Expense | ||
| ( – ) Salaries & Wages Expense | ||
| ( – ) Telephone Expense | ||
| ( – ) Utilities Expense | ||
| ( = ) Operating Income | ||
| Other Income/Expenses; Gains and Losses: | ||
| ( + ) Interest Income | ||
| ( + ) Dividend Income | ||
| ( + ) Gain on Sale of PPE | ||
| ( + ) Gain on Sale of Investments | ||
| ( – ) Interest Expense | ||
| ( – ) Loss on Sale of PEE | ||
| ( – ) Loss on Sale of Investments | ||
| ( = ) Income Before Income Taxes | ||
| ( – ) Income Tax Expense | ||
| ( = ) Net Income | ||
The multi-step income statement follows a predictable format. Items are always shown in the same order so a reader (a) can get specific information about different types of profit and (b) can find information quickly. Let’s break this statement down into small sections. That way we can look more closely at the unique information presented in each part of the income statement.
- Title.
- Like all financial statements, the multi-step income statement starts with a title. The order and wording of the title is important. This title lets the reader know they’re in for an exciting story about Sample Company’s income over the year from 01 January to 31 December 20X1.
- Gross Profit.
- The first line on the multi-step income statement is sales or service revenue. You may refer to business model here, looking at whether does the company create value by selling items or by providing services. If the company sells products as a wholesalerWholesaler:
A company with a business model of selling inventory to a retailer. The role of a wholesaler is as a distribution center for products. or retailer, they will have cost of goods sold (COGS). Remember the idea of mark-up or gross profit? Just as we said, sales less COGS equals gross profit. So, you already know how to do this; well done! - Operating Income.
- After gross profit, we have operating expenses. Basically, you can take all expenses, except interest expense and income tax expense, and list them here. These expenses are listed in alphabetical order, but the ordering isn’t terribly important. You may notice that there are expenses we haven’t really discussed in this list. That’s true, but I want you to have a fairly comprehensive list of possible expenses you may see in this class.
- When we add up all the operating expenses and subtract them from gross profit, we get operating income. Operating income is super important for everyone who uses financial statements because it’s the profit made from running the company’s business model for the whole year. We can expect that operating income will be similar next year (or even higher?) because all these income and expense items are recurring. They happen every year. One could say that operating income has predictive value: it helps users predict what profit will be next year. Cool right?
- Income Before Taxes.
- The next section is all the peripheral items which we will call other income and expenses; gains and losses. This section included all those gains and losses on sales of non-current assets as well as interest items. Let’s list all the items that get added first, then all the items that are subtracted. When we add all the peripheral income and gains, and subtract all the peripheral expenses and losses, we get income before taxesIncome Before Taxes:
Calculated as operating income less peripheral items (other income and expenses; gains and losses). Income before taxes includes all income statement items except for income tax expense, and is the starting point for a company’s tax return.. - Net Income.
- Almost there! Remember we said that income tax expense belongs at the bottom of the Income Statement? Well, it gets included last because it’s based on income before taxes—usually as a percentage. So, if a company’s tax rate is 20%, and their income before taxes is $100,000, their income tax expense will be $20,000 (calculated as 100,000 × 20%). So, can you see how it’s helpful to calculate an income figure before applying tax? It’s because tax is mathematical based on income before tax. After income tax expense is subtracted, we have net income and we’re done!
If you’re counting, we have four profit figures: Gross Profit, Operating Income, Income Before Taxes, and Net Income. Each profit figure gives us unique insight into the company. We find out:
- what the mark-up is on products (Gross Profit),
- how much financial value the company has generated for investors by operating their business model (Operating Income),
- the profit used to calculate income taxes (Income Before Taxes), and
- the total profit that belongs to investors (Net Income).
Net Income is referred to as the bottom line, and it belongs to shareholders. This is the amount that will be transferred to Retained Earnings.