In order for small businesses to thrive, they must in one way or another, keep proper records. And all these transactional records eventually lead to the creation of a 3 statement report. The Income statement (The Profit and Loss Statement), the Balance Sheet (The statement of financial position) and the cash flow. All these are crucial in understanding the whole view of a company’s financial performance. However, we shall, in this piece, look at the income statement and what it entails.
What is an Income Statement?
The income statement focuses on four key items: Revenue, Expenses, Gains, and Losses. It does not differentiate between cash and non-cash sales (sales in cash versus sales on credit) or cash versus non-cash payments (purchases in cash versus purchases on credit). The Income statement is highlighted below;
The green figures represent income while the red figure in brackets represent expenses. On the totals, green represents profit while red represents a loss.
Revenue and Gains: Blue Outline
The blue outline represents the Revenue and Gains section which comprises of the operating revenue and non-operating revenue;
Operating Revenue – This is revenue gained from the core business of the company. E.g. a retail reselling company by stock at say Kshs 300,000 (Cost of Goods) and then sells it at Kshs 1,000,000 (Turnover). The Kshs 1 mn is the operating revenue
Non-Operating Revenue – This is revenue gained from other activities that are not part of the core business. E.g. the same retail company invested some excess cash in a bond. The interest earned is a non-operating revenue. If they happened to sell stock on behalf of a 3rd party and collect a commission, this is also a non-operating income.
Gains – These are one-off items. E.g. Sale of fixed assets like computers etc.
Expenses and Losses: Black Outline
The black outline represents expenses and losses incurred in the business.
Operating Expenses – These are expenses incurred in the normal running of a business. These include, Cost of goods sold, selling and distribution expenses and general and administrative expenses as shown above
Non-Operating Expenses – These are expenses incurred but not from activities of running the business. These include interest on a loan.
Losses – These are one-off expenses like losses incurred on the sale of assets like computers etc.
Net Income
Net Income = (Revenues + Gains) – (Expenses + Losses)
If (Revenues + Gains) is greater than (Expenses + Losses) then the company made a profit. If (Revenues + Gains) is less than (Expenses + Losses) then the company made a loss. This is the basic principle of the Income Statement.
Uses of Income Statement
The income statement gives details on the profitability and operational activities of the company. It also provides detailed insights for comparison across different businesses and sectors.
According to Investopedia, based on income statements, management can make decisions like expanding to new geographies, pushing sales, increasing production capacity, increased utilization or outright sale of assets, or shutting down a department or product line.
Conclusion
For small businesses, an income statement can enable one to be more professional in running your business. How much money am I making, which product lines perform better, which ones need more boosting, which expense is a risk to the business, is there a need to diversify, do I need to move to a better location? Etc. Apart from inward-looking, Income statements can enable you to benchmark with competitors to see where you fair and whether you need to step up your game.
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