An income statement, also known as a profit and loss statement, is one of the four main financial statements an accountant can produce for your business. Like with the balance sheet, an income statement tells you important financial details about how your business is running.
Specifically, an income statement tells you the net income of your business over a certain financial period. This is calculated using the following equation:
NET INCOME = (TOTAL REVENUE + GAINS) – (TOTAL EXPENSES + LOSSES)
An accountant will use all these individual elements of financial information – recorded throughout the accounting period by a bookkeeper – to produce an income statement.
We’ll break that equation down a little later, for now lets look at why you need an income statement!
Firstly, an income statement helps a business owner to understand the financial health of their company. By tracking revenues and expenses, the income statement gives you a good idea of the financial progress made by your company over the accounting period.
From this information, the business owner can make better informed financial decisions and support the future growth of the business.
So, what makes up an income statement?
Your income statement should show everything mentioned in the equation above. Usually the revenue and gains are listed first, then the expenses and losses. That way, you subtract the total expenses from the total revenue to arrive at the bottom line.
This bottom line shows the net income for your business over the accounting period.
Understandably, there are a lot of terms to keep track of here, so let’s break some of them down.
Revenue refers to the money a business earns directly from the sale of goods or services.
For example, if your pet shop business sold 25 bags of dog food for £4 each, your revenue for that day would be £100. The revenue itself doesn’t take into account the costs of business – this will be shown by the net worth.
Gains are a little more complex than revenue. A gain refers to the income made through the sale of a long-term asset, such as machinery used in production.
A gain is earned when the proceeds for the sale of the asset are greater than it’s book value.
Simply put, an expense refers to the operating costs of running your business. This could be any number of things – payments to suppliers, manufacturing costs or even depreciation of equipment.
Some of these expenses may qualify for tax deductions from HMRC – especially those considered ‘allowable expenses’ or running costs. It’s worth taking a look to see where you might be able to save money.
A loss, unlike an expense, refer to costs that are not a consequence of the running of your business. Remember that example of a gain? A loss might be the opposite of this – if the book value of an asset is greater than the income from it’s sale.
Net income is the bottom line of an income statement. Going back to the equation, it shows the total value of revenue left over after expenses have been subtracted.
This value gives you an idea of the financial health of your business and whether you are running a sustainable model.
Creating an income statement
Hopefully this guide has helped you to see what an income statement is and why it’s so important to your business. If you need more information on accounting, bookkeeping or anything financial, check out our educational guides here.
That being said, we know that you didn’t start a business so you could create financial statements.
Luckily for you, Count did! Let Count handle all your financial worries so you can focus on running your business! Check us out here to see what we can do for you.