The Basic Accounting Equation.
The 3 Financial Statements :
1. The Income Statement
2. The Balance Sheet & The Statement of Retained Earnings
3. Cash Flow Statement.
The Income Statement
Revenue – Expenses = Income
Revenues are earned for the sale of goods or services. Revenues occur when the sale is made.The payment may or may not have been received. Examples of Revenues include sale of goods, service revenues and interest revenues.
Expenses are incurred when a business receives goods and services. Like revenue, payment may or may not have been made.Examples of expenses include salaries, expenses, utility expenses, interest expense etc.
Most businesses require more information from their business than a simple income statement can provide. Therefore, they use a multistep income statement format.
The format for a multistep income statement is below:
Sales Revenue
– Cost of goods sold
= Gross Profit
– Operating Expenses
= Operating Income or Profit
+/- Non-operating items
= Income before taxes
– Income Taxes
= Net Income or Profit after tax
Cost of Goods Sold represents the expense a business incurs to buy or make a product for resale. For example: A furniture store buys a chair for INR 2,000/- and then sells it for INR 3,000/-. Here the cost of goods sold is INR 2,000/-
Operating expenses are the usual expenses incurred in operating the business. Accounts such as salaries, utilities and depreciation expenses are all shown in this section.
Non-Operating items are revenues and expenses, gains and losses that do not relate to the company’s primary operations. Example: Interest income and Interest expense (exception banks), gain or loss on sale of equipment’s etc.
Income Taxes are computed by multiplying Income before taxes by the income tax rate.
Example: Income before taxes is INR 1,00,000/-
The income tax rate is 30%. Income tax = INR 1,00,000 X 30% = INR 30,000/-
What to see in P&L statement / Income Statement?
– Trends in Net Sales
– Trend in Cost
– Trend in Net Profits
In the next article we will be taking a closer look at the Balance Sheet.