In my last post I showed a very simplified graphic of the Income Statement to emphasize that it is a “Flow” statement as opposed to the “Static” nature of the Balance Sheet. And by the way, the Income Statement is generally considered the more important of the two. This is because (1) it covers a period of time rather than a one day snapshot, (2) it measures the critical relationship of the business with its customers and market (sales), and (3) it expresses through the Gross Profit and Margin the intrinsic value those customers place on the product or service offered by the business. Here we will put a little more “meat on the bones” of the Income Statement … although still quite summary in form:
Notice that this example is for the 3rd calendar quarter of 2011. “Sales” is the term reserved for revenue generated by or with customers. If the business has other types of revenue (rent, royalties, interest, etc.) those should be segregated from sales.) If the primary business is selling a product, the direct cost of that product (whether bought from a vendor or produced internally) is calculated and presented as Cost of Goods Sold. Subtracting this from Sales derives the Gross Profit expressed in dollars, which is normally also shown as a percent of sales, the Gross Profit Margin or GPM%. The various operating expenses are then organized and presented, usually with sub-headings and sub-totals. These are normally clustered into Sales Expenses, General and Administrative … thus earning the moniker “SG&A”. The total SG&A is in turn subtracted from the Gross Profit to derive the Operating Income or Profit of the main business. Most businesses will also have some miscellaneous income and a few minor expenses that are not directly related to or driven by the function of the business. These are usually shown as “Other Income / Expense” or “Non-Operating Income / Expense”. There is flexibility and discretion as to how these are presented with materiality guiding how much detail is shown. Sometimes just the net of the combination is shown. When subtracted or added to the Operating Income, we finally arrive at the Net Income of the business. However, this is a before or “Pre-Tax” number. If the business is a partnership, a Limited Liability Corporation or a regular corporation that has elected to be taxed like a partnership (called a Sub-S election) the pre-tax profit will be shared among the various owners pro-rata to their share of ownership and reported on their individual tax returns. If it is a regular corporation (called a C-Corp) it will owe and make provision for federal taxes (at least) and show that on the Income Statement as seen above.
Douglas K. Steele