How to Read & Understand Your Statement of Income or Profit and Loss Statement

In order to ascertain the financial health of a company, it is important to be able to read and understand the statement of income. This is one of the main financial statements of an organization, along with the balance sheet, statement of cash flows and statement of retained earnings. The income statement is also frequently referred to as a profit and loss statement because it shows the net profits or losses that a company realizes over a certain period of time.

Instructions

1. Look at the heading and note the date of the report and the period that it is reporting the financial information for. This can be found at the top of the income statement and usually says "for the period ending December 31, 2011" or whatever date the report is created.

2. Make note of how the financial data is recorded. A company does not usually record the financial data at the full amount, but instead reduces it uniformly. In the heading, usually in parentheses, you will also find a statement that discloses how much each piece of data should be multiplied by to reach the actual amount. For example, "(in millions)" means that when office supplies expense is listed at $1.2 it really means $1,200,000.

3. Examine the first section of the statement of income which pertains to the revenues that the organization received from sales of products or services and the gross profit (or loss) of the company. In this section you may find a subcategory called "cost of goods sold." This line indicates how much it costs to make the inventory that the company sells. Subtracting this total value from revenues, or sales, indicates the gross profit (or loss) of the company. It is important to note that sales, or revenues, do not equate to the reception of cash. Although revenues may be recognized when using accrual based accounting, it does not mean the customer has yet paid the company.

4. Review the subsequent sections which list the operating expenses of the organization. Operating expenses include selling and administrative expenses, such as office supplies, advertising, commissions, utilities and vehicle expenses. Other types of operating expenses include depreciation, property taxes, legal and accounting fees, and fees to maintain the facility such as trash removal and lawn care. Subtracting the total operating expenses from the company's gross profits will give you the operating income (or loss) of the organization, or what the company earned from operations for this reporting period.

5. Examine the final section of the income statement which relates to revenues and expenses that the company incurs and are not related to operations. It also includes any gains or losses from a sale of property or lawsuits. Most revenue and expenses in this section relate to investments that the company has made. After adding together gains and revenues, then subtracting expenses and losses, the total will either be positive or negative. Add a positive value to the operating income (or loss) and subtract a negative value. The value that remains is the company's gross profit (or loss) for the reporting period. It is the total amount that the company earned (or lost) over that period of time.

Tips & Warnings

• In the company's annual report, notes to the financial statements will frequently accompany each financial statement. These often reveal pertinent information about the financial data within the statements. Read and review them carefully.

• If you are attempting to create a statement of income for the first time, enlist the help of a more experienced person. Double check the expenses and revenues that the bookkeeper or accountant inputs into your accounting software. Human error can cause major mistakes on a company's financial statements.

References

• "Intermediate Accounting"; D. Kieso, et al.; 2007
• "Managerial Accounting"; R. Kaplan, et al.; 2004
• Accounting Coach: Income Statement (Profit and Loss Statement)