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The ‘Income Statement’, or ‘Profit and Loss Statement’ (P&L) is one of the three major Financial Statements, along with the Balance Sheet and the Statement of Cash Flows. In this tutorial, you’ll find out what the Income Statement is and how you can use it to measure a business’s financial performance.
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00:00 – Intro
01:02 – Income Statement Definition
01:10 – What a Basic Income Statement Looks Like
02:10 – An Analogy
02:37 – Expanding the Income Statement
03:16 – Direct Costs – Cost of Sales
04:48 – Gross Profit
05:10 – Indirect Costs – Overheads
06:15 – Operating Profit
06:42 – Comparative Periods
07:18 – Example – Imaginary Company
08:17 – Financial Ratio Analysis – Gross Profit Margin
09:34 – Interest Expenses & Tax
10:01 – Net Profit
10:12 – Gross Profit vs Operating Profit vs Net Profit
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In this video you’ll learn
what an income statement is. I’ll show you what it looks like
and how you can use it to measure a business’s
financial performance. [Music] Hey there welcome back to Accounting Stuff
I’m James and in today’s video we’re going to cover the
income statement also known as the
profit and loss statement or the P&L.
This is one of the three major financial statements in accounting
along with a balance sheet and the cash flow statement.
Collectively these reports give us an impression of a
business’s financial health so it’s important that we understand
how they work. I’ve already made videos covering
the balance sheet and the.
cash flow statement which you can
find linked up here and down below in the description.
But up until now I haven’t posted a video yet on the income statement
and I’ve received a lot of requests from you guys to cover this topic
so thanks for all these particularly from one subscriber
so Niloy, if you’re watching.
this video goes out to you
good luck in your exam hope you crush it!
An income statement is the summary of a business’s revenues
and expenses over a period of time. In its basic form
an income statement looks like this. It’s a summary of a business’s
revenues and expenses over a period of time.
When we take our total revenue and.
subtract our expenses from it
then we work out our profit or our loss. We make a profit when our revenues
exceed our expenses and on the flip side
we make a loss when our expenses are more than the income we’ve earned.
This is why the income statement is also known as the
profit and loss statement or the P&L.
It lays out a roadmap for how we ended up here
at the bottom line our profit or loss.
The income statement always covers a period of time
which could be anything that we want it to be but typically
we run it for a month a quarter or a full year.
Here’s a helpful analogy that I read in this book
the accounting game.
which I recommend reading
if you’re new to accounting you can find my review of it up here.
Anyway back to it. If a balance sheet shows us a
snapshot of a business’s assets liabilities and equity at a
single point in time then you can think of it as a photograph
or a still frame taken from a video. Whereas the income statement
covers a period of time.
it’s like watching a clip of that video
it has a beginning and it has an end and if we look at it carefully
and analyse it then it can tell us a story but more on that later.
Let’s take a closer look at our income statement.
Revenues less expenses make us a profit or a loss.
The problem with this layout.
is that it doesn’t give us much detail
it would be much better if we made things a little more
descriptive for instance revenue
there are many different types of revenue.
If we were running a business that sells physical products then we might want to
call this product sales instead or if we provide services we can call this
our services rendered..
This extra detail helps the readers
of the income statement better understand what they’re looking at.
Clarity is the aim of the game here. The same goes for expenses
businesses typically incur many different types of expense
but broadly speaking these can be broken down into two categories
our direct costs of doing business.
and our indirect costs of running the business.
Our direct costs of doing business are the costs which we can directly
trace through to the products we’ve sold or the services
that we’ve provided. For a business that provides services
we might call this our cost of services and if we sell physical goods
then we can call this our cost of sales.
or our cost of goods sold.
Direct costs like these are variable costs which increase in direct proportion to
the sales that we’ve made. If you were running a retail or
a wholesale business then these would include things like
the original purchase price of the product that you’re reselling
or if you’ve run a manufacturing business.
then this would include the cost
of your raw materials or the direct labor cost
that went into producing your product. As we make more sales
we incur more of these direct costs. Cost of goods sold can be
a bit of a tricky concept to understand at first.
It ties in very closely with inventory in the balance sheet.
If you’d like to see me make a video.
explaining how all of that works
then let me know down below in the comments
and if you haven’t already remember to hit that subscribe button
so you don’t miss out on all of the other accounting tutorials
that we have coming out very soon. Back to the income statement.
When we take our revenue and deduct our direct costs
of doing business.
we get to our gross profit.
If you’re new to accounting then you’ll soon discover that we have
many different types of profit. Our gross profit is a really useful tool
that allows us to measure the efficiency of our
production and sales process. I’ll show you how that
works in a minute but first let’s jump back to indirect costs.
These are the costs.
of running a business
which can’t directly be traced back to the production of goods
or the provision of services. We sometimes call these overheads.
Overheads can include fixed costs like rent
employee salaries insurance costs
admin expenses legal costs
accounting costs marketing costs
depreciation and amortisation.
there’s a lot of them!
Fixed costs like these tend to remain the same
they bear no correlation at all to the sells that your business has made.
However not all overheads are fixed. Variable overheads can loosely correlate
with a business’s sales although they can’t be directly
traced back to the production of goods.
or the provision of services.
These include things like advertising costs which can
indirectly drive sales and sales commissions.
Utility costs could also be considered a variable overhead
in a manufacturing business because these can increase
as we ramp up production. When we deduct our indirect costs
of doing business from our gross profit.
we come to our operating profit.
Operating profit measures the net income that we’ve
generated from operations this is the residual amount that’s
left over after deducting all of our direct
and indirect costs of doing business. So this is our basic income statement
but how does it help us measure a business’s financial health?
It does that by giving us a means.
to compare our financial performance
against comparative accounting periods. A comparative period
is a different period of time. It can be whatever we want it to be
we can compare a current month income statement against
last month’s income statement or this year versus last year.
When we use comparative periods.
we can calculate the change
or movement across each line item down the profit and loss statement
and as accountants it’s our job to support these movements
with a narrative which explains all of the differences.
Let’s throw in some numbers into an imaginary company
and I’ll show you what I mean. We’ll compare the movements
in our P&L year-on-year..
This is going to be for a
medium-sized business so we can quote our numbers
in thousands of dollars. What have we got here?
Our imaginary company has made sales of
a hundred and ten thousand dollars which is up ten thousand dollars
from what we made in the prior year. Our cost of goods sold
have also increased by.
ten thousand dollars
from $30,000 to $40,000 that’s left us with a gross profit
of seventy thousand dollars which has remained unchanged.
Our overheads are fixed at forty five thousand
which gives us an operating profit of twenty five thousand dollars
in each period. What can we learn from all of this?
Well our sales have increased.
by ten thousand dollars but our
gross profit has remained exactly the same. How can that be?
A useful metric that we can use to analyse this is gross profit margin.
We can calculate our gross profit margin by taking our total product sales
and deducting our costs of goods sold and then dividing the whole lot
by our product sales..
This measures how efficiently we’ve
been producing and selling our imaginary product.
In this case our gross profit margin in the current year is around 64%
which is actually down from last year’s gross profit margin of 70%.
How is that possible? Well one of two things
could be happening here. Our sales can be shrinking
or our costs could be rising..
We could be selling more products
but at a discount or the cost of our raw materials
could be rising. These are the questions that
we need to be asking ourselves as accountants
investors or small business owners. We can compare metrics
like the gross profit margin across comparative periods to
help us identify what questions.
we should be asking
and then that’s when the work begins. We need to find out the answers
and use them to build a narrative that explains what’s going on.
Gross profit margin is just one of many business metrics that we can use
to analyse the income statement. If you’d like to see me make videos
on the others let me know..
Now this is still quite a
basic income statement. In reality there are other indirect costs
of doing business which we might need to include as well.
Things like interest expenses and tax. These tend to slot in below
operating profit because they aren’t considered
to fall within the normal cost of operations.
This is why operating profit.
is also known as EBIT or
earnings before interest and tax. When we deduct
interest in tax from our operating profit
we calculate our net profit the bottom line
because it’s at the bottom of the profit and loss statement.
So you can see that there are many different types of profit and loss
to consider in accounting..
We start off with our revenue
and we deduct our direct costs of doing business to come to
our gross profit our top-line profit.
Below this we take out the indirect costs of
running our business to find our operating profit
our EBIT our earnings before interest and tax
and when we remove interest and tax.
we calculate our net profit
the bottom line. Together these different
types of profit help us measure performance over a period of time.
The main goal of most businesses is to maximise their profits
so it’s important to be clear on what that means
and to be aware of the differences between gross profit
operating profit and net profit.
which can each tell us
a different part of the story. Like I mentioned earlier
the income statement is just one of the three main financial statements
along with the balance sheet and the cash flow statement.
I’ve made videos covering both of these already
which you can find here and here. If you found this one useful
give it a like.