0:02 in this video you'll learn what's an
0:04 income statement is I'll show you what
0:06 it looks like and how you can use it to
0:07 measure a business's financial
0:14 performance hey there welcome back to
0:16 accounting stuff I'm James and in
0:18 today's video we're going to cover the
0:20 income statement also known as the
0:24 profit and loss statement or the P&L for
0:26 short this is one of the three major
0:28 financial statements in accounting along
0:30 with a balance sheet and the cash flow
0:32 statement collectively these reports
0:34 give us an impression of the business's
0:36 financial health so it's important that
0:39 we understand how they work I've already
0:40 made videos covering the balance sheet
0:42 and the cash flow statement which you
0:44 can find linked up here and down below
0:47 in the description but up until now I
0:49 haven't posted a video yet on the income
0:51 statement and I've received a lot of
0:52 requests from you guys to cover this
0:54 topic so thanks for all these
0:57 particularly from one subscriber so Nili
0:59 if you're watching this video goes out
1:01 to you good luck in your exam hope you
1:04 crush it an income statement is the
1:06 summary of a business's revenues and
1:10 expenses over a period of time in his
1:12 basic form an income statement looks
1:15 like this it's a summary of a business's
1:19 revenues and expenses over a period of
1:22 time when we take our total revenue and
1:24 subtract our expenses from it then we
1:27 work out our profit or our loss we make
1:30 a profit when our revenues exceed our
1:33 expenses and on the flip side we make a
1:35 loss when our expenses are more than the
1:37 income we've earned this is why the
1:39 income statement is also known as the
1:42 profit and loss statement or the P&L for
1:44 short it lays out a roadmap for how we
1:47 ended up here at the bottom line our
1:50 profit or loss the income statement
1:52 always covers a period of time which
1:54 could be anything that we wanted to be
1:56 but typically we run it for a month a
1:59 quarter or a full year here's a hopeful
2:01 analogy that I read in this book the
2:04 accounting game which I recommend
2:05 reading if you're new to accounting you
2:09 can find my review of it up here
2:12 back to it if a balance sheet shows us a
2:14 snapshot about business's assets
2:17 liabilities and equity at a single point
2:19 in time then you can think of it as a
2:22 photograph or a still frame taken from a
2:24 video whereas the income statement
2:26 covers a period of time it's like
2:29 watching a clip of that video it has a
2:31 beginning and it has an end and if we
2:34 look at it carefully and analyze it then
2:36 it can tell us a story but more on that
2:40 later let's take a closer look at our
2:45 income statement revenues less expenses
2:48 make us a profit or a loss the problem
2:50 with this layout is that it doesn't give
2:52 us much detail it would be much better
2:54 if you made things a little more
2:57 descriptive for instance revenue there
2:59 are many different types of revenue if
3:01 we were running a business that sells
3:03 physical products then we might want to
3:06 call this product sales instead or if we
3:08 provide services we can call this our
3:11 services rendered this extra detail
3:13 hopes the readers of the income
3:15 statement better understand what they're
3:17 looking at clarity is that a movie game
3:20 here the same goes for expenses
3:22 businesses typically incur many
3:24 different types of expense but broadly
3:26 speaking these can be broken down into
3:30 two categories or direct costs of doing
3:32 business and are indirect costs of
3:35 running the business or direct costs of
3:37 doing business are the costs which we
3:39 can directly trace through to the
3:41 products we've sold or the services that
3:43 we've provided for a business that
3:45 provides services we might call this our
3:48 cost of services and if we sell physical
3:51 goods then we can call this our cost of
3:54 sales or our cost of goods sold direct
3:56 costs like these are variable costs
3:59 which increase in direct proportion to
4:01 the sales that we've made if you were
4:03 running a retail or a wholesale business
4:05 then these would include things like the
4:07 original purchase price of the product
4:10 that you're reselling or if you've run a
4:12 manufacturing business then this would
4:14 include the cost of your raw materials
4:16 or the direct labor cost that went into
4:19 producing your product as we make more
4:20 sales we incur more
4:24 of these direct costs cost of goods sold
4:26 can be a bit of a tricky concept to
4:28 understand at first it ties in very
4:30 closely with inventory in the balance
4:32 sheet if you'd like to see me make a
4:34 video explaining how all of that works
4:36 then let me know down below in the
4:38 comments and if you haven't already
4:41 remember to hit that subscribe button so
4:42 you don't miss out on all of the other
4:44 accounting tutorials that we have coming
4:47 out very soon back to the income
4:50 statement when we take our revenue and
4:52 deduct our direct costs of doing
4:55 business we get to our gross profit if
4:57 you're new to accounting then you'll
4:58 soon discover that we have many
5:01 different types of profit our gross
5:03 profit is a really useful tool that
5:05 allows us to measure the efficiency of
5:07 our production and sales process I'll
5:10 show you how that works in a minute but
5:12 first let's jump back to indirect costs
5:14 these are the costs of running a
5:17 business which can't directly be traced
5:19 back to the production of goods or the
5:22 provision of services we sometimes call
5:24 these overheads overheads can include
5:28 fixed costs like rent employee salaries
5:31 insurance costs admin expenses legal
5:34 costs accounting costs marketing costs
5:37 depreciation and amortization for
5:39 there's a lot of them fixed costs like
5:42 these tend to remain the same they bear
5:45 no correlation at all to the sells that
5:48 your business has made however not all
5:51 overheads are fixed variable overheads
5:53 can loosely correlate with a business's
5:55 sales although they can't be directly
5:57 traced back to the production of goods
5:59 or the provision of services these
6:02 include things like advertising costs
6:04 which can indirectly drive sales and
6:07 sales commissions utility costs could
6:09 also be considered a variable overhead
6:12 in a manufacturing business because
6:14 these can increase as we've ramped up
6:16 production when we deduct our indirect
6:19 costs of doing business from our gross
6:22 profit we come to our operating profit
6:25 operating profit measures the net income
6:28 that we've generated from operations
6:30 this is the residual amount that's left
6:33 over after deducting all of our direct
6:36 and indirect costs of doing business so
6:39 this is our basic income statement but
6:41 how does it help us measure a business's
6:43 financial health it does that by giving
6:46 us a means to compare our financial
6:47 performance against comparative
6:50 accounting periods a comparative period
6:53 is a different period of time it can be
6:56 whatever we want it to be we can compare
6:59 a current month income statement against
7:01 last month's income statement or this
7:04 year versus last year when we use
7:06 comparative periods we can calculate the
7:09 change or movement across each line item
7:11 down the profit and loss statement and
7:13 as accountants it's our job to support
7:15 these movements with a narrative which
7:18 explains all of the differences let's
7:20 throw in some numbers into an imaginary
7:22 company and I'll show you what I mean
7:25 we'll compare the movements in our P&L
7:28 year-on-year this is going to be for a
7:30 medium-sized business so we can quote
7:33 our numbers in thousands of dollars what
7:36 have we got here our imaginary company
7:38 has made sales of a hundred and ten
7:41 thousand dollars which is up ten
7:42 thousand dollars from what we made in
7:45 the prior year our cost of goods sold
7:47 have also increased by ten thousand
7:52 dollars from $30,000 to $40,000 that's
7:54 left us with a gross profit of seventy
7:56 thousand dollars which has remained
7:59 unchanged our overheads are fixed at
8:01 forty five thousand which gives us an
8:04 operating profit of twenty five thousand
8:06 dollars in each period what can we learn
8:09 from all of this well our sales have
8:12 increased by ten thousand dollars but
8:15 our gross profit has remained exactly
8:18 the same how can that be a useful metric
8:20 that we can use to analyze this is gross
8:24 profit margin we can calculate our gross
8:26 profit margin by taking our total
8:29 product sales and deducting our costs of
8:31 goods sold and then dividing the whole
8:33 Lots by our product sales this measures
8:36 how efficiently we've been producing and
8:38 selling our imaginary product in this
8:41 case our gross profit margin in the car
8:44 here is around 64% which is actually
8:46 down from last year's gross profit
8:50 margin of 70% how is that possible well
8:52 one of two things could be happening
8:55 here our sales can be shrinking or our
8:57 costs could be rising we could be
9:00 selling more products but at a discount
9:02 or the cost of our raw materials could
9:04 be rising these are the questions that
9:06 we need to be asking ourselves as
9:09 accountants investors or small business
9:12 owners we can compare metrics like the
9:14 gross profit margin across comparative
9:16 periods to help us identify what
9:19 questions we should be asking and then
9:21 that's when the work begins we need to
9:23 find out the answers and use them to
9:26 build a narrative that explains what's
9:28 going on gross profit margin is just one
9:30 of many business metrics that we can use
9:32 to analyze the income statement if you'd
9:34 like to see me make videos on the others
9:37 let me know now this is still quite a
9:40 basic income statement in reality there
9:42 are other indirect costs of doing
9:43 business which we might need to include
9:46 as well things like interest expenses
9:49 and tax these tend to slot in the lower
9:51 operating profit because they aren't
9:53 considered to fall within the normal
9:56 cost of operations this is why operating
9:59 profit is also known as EBIT or earnings
10:02 before interest and tax when we deduct
10:04 her interest in tax from our operating
10:08 profit we calculate our net profit the
10:09 bottom line because it's at the bottom
10:12 of the profit and loss statement so you
10:14 can see that there are many different
10:16 types of profit and loss to consider in
10:18 accounting we start off with our revenue
10:21 and we deduct our direct costs of doing
10:23 business to come to our gross profit of
10:26 top-line profit below this we take out
10:28 the indirect costs of running our
10:30 business to find out operating profit
10:33 our EBIT our earnings before interest
10:36 and tax and when we remove interest and
10:39 tax we calculate our net profit the
10:41 bottom line together these different
10:42 types of profit help us measure
10:45 performance over a period of time the
10:47 main goal of most businesses is to
10:49 maximize their profits so it's important
10:51 to be clear on what that means and to be
10:53 aware of the differences between gross profit
10:54 profit
10:56 operating profit and net profit which
10:58 can each tell us a different part of the
11:00 story like I mentioned earlier the
11:02 income statement is just one of the
11:04 three main financial statements along
11:06 with the balance sheet and the cash flow
11:09 statement I've made videos covering both
11:11 of these already which you can find here
11:13 and here if you found this one useful
11:15 give it a like or better yet share with
11:17 a friend why not don't forget to
11:19 subscribe for more accounting tutorials
11:20 I'll see you around [Music]
