The Anatomy of an Income (Profit and Loss) Statement

Understanding an Income Statement

An Income Statement, also known as a Profit and Loss statement, or P&L, provides a summary of a company's revenues, expenses, and profits over a specified period of time, usually a month, quarter, or a year. It is one of the three main financial statements, along with the balance sheet and the cash flow statement. We will discuss the other financial statements in subsequent posts.

The Income Statement shows how much revenue a company generates, how much it spends on expenses, and how much profit it makes. It is useful for understanding a company's financial performance and profitability.

Before we continue, I’d like to clarify a significant point when it comes to the terms income and revenue. Many people use thes terms “Income” and “Revenue” synonymously (as though they are the same).  However, they are quite different when we are talking about them in accounting terms. In the food service industry, we often use the term “Sales”. What were Sales for last night, 1st shift, etc.? However, for the purpose of this article, the term “Sales” is the equivalent of the term Revenue.

We can understand the Income Statement to be broken down into several key sections:

• Revenue

• Cost of Goods Sold

• Gross Income

• Operating Expenses

• Net Income

Revenue is the amount of money that a business takes in. It is the total amount of money that a business collects at its Point-of-Sale system.

Income, on the other hand, can come in two forms; Gross Income and Net Income. Before we delve into income, let’s review the Cost of Goods Sold.

Cost of Goods Sold (COGS) has two components; Raw Materials and Labor.

Raw materials are the cost of ingredients utilized for the products the business sells. For a bakery it is the costs associated with the ingredients necessary to produce a product. For example, the purchase price of flour, milk, sugar, eggs, etc.

Labor is only the portion of labor costs associated with directly producing a business’ final products that they sell. So for our bakery, it would be the costs of the pastry chef and supporting production staff used to produce the products that are sold. It is NOT the labor costs of the sales clerk working the front counter selling the products. Even if this is the same person performing production and selling, the direct production labor costs must be separated from the operation labor costs to get an accurate picture of COGS for labor.

Now, back to income.

Gross Income is the amount of money that remains after a company has paid for all of the production [raw] materials and production labor (a.k.a. Cost of Goods Sold or COGS).
This formula is [Gross Income = Revenue minus Cost of Goods Sold].

Sandwiched in-between Gross Income and Net Income is Operating Expenses.

Operating Expenses (OPEX) are the costs incurred to operate the business. These costs are everything from rent, utilities, insurance, advertising/marketing costs, payroll, to website costs, etc.

Net Income is the amount of money left over after a company pays for its Operating Expenses.
This formula is [Net Income = Gross Income minus Operating Expenses].

So, at a high level, the Income Statement (Profit & Loss), tells us the

1. The amount of Revenue the business generated

2. The amount of Production Costs to earn that Revenue (COGS)

3. The amount of Gross Income (Revenue - COGS)

4. The amount of Operating Expense (OPEX) and

5. The amount of Net Income - what remains after deducting OPEX - a.k.a. “the bottom line”

Summary

Now that we have an understanding of sections of the Income Statement (Profit & Loss), we will understand what it means when someone asks, “What is your bottom line?” Well, what they are asking is, “What is your Net Income?” This tells you whether you are making money or losing it. And that is what really matters in any business.

In our next post, we will examine the Anatomy of a Balance Sheet