The income statement, also known as the profit and loss (P&L) statement, is a crucial financial report that summarizes a business's revenues and expenses over a specific period to determine its profitability.
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in this video you'll learn what's 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 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 for
short 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 the 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 Nili
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 his
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 for
short 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 wanted to be
but typically we run it for a month a
quarter or a full year here's a hopeful
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
back to it if a balance sheet shows us a
snapshot about 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 analyze 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 you 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
hopes the readers of the income
statement better understand what they're
looking at clarity is that a movie 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 or direct costs of doing
business and are indirect costs of
running the business or 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 amortization for
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've ramped 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 analyze 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
Lots 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 car
here 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 analyze 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 the lower
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
her 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 of
top-line profit below this we take out
the indirect costs of running our
business to find out 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
maximize their profits so it's important
to be clear on what that means and to be
aware of the differences between gross profit
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 or better yet share with
a friend why not don't forget to
subscribe for more accounting tutorials
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