Now that you are armed with the basic knowledge of what an Income Statement is , it’s important to understand what the Income Statement actually tells you.
- The Income Statement reports the main and any secondary sources of income. For example, Services would be the primary revenue in a Bookkeeping Service. If you had a bank account that earned interest, a secondary source of revenue would be Interest Earned.
- The terms used to describe the revenue will provide a clue about the nature of the organization. For example, Services implies a service company; while Sales Revenue implies a retail or wholesale firm.
- The items listed as expenses are expired, meaning they have no useful value left.
- The result of matching the revenues and expenses yields the Net Income. The term ‘net’ implies that the revenues and expenses have been matched, and therefore there is not an over or under statement of the income (loss).
What an Income Statement does not tell you
- An Income Statement does not predict the future net income for any accounting period. The future is full of uncertainty.
- An Income Statement does not report True Profit, which is the difference between total funds invested over the life of the company and funds realized from the sale of the company. To calculate this, you would have to calculate the difference between assets invested during the lifetime of the business, and the amount finally received from remaining assets after winding up the business. You would also have to deduct any personal withdrawals because these were actually paid out of the ‘profits.’
- Net Income does not mean cash! Always keep in mind that net income is the excess revenue over related expenses for a specific accounting period. Cash has very little to do with determining net income. Additionally, revenues and expenses are recorded at the time of occurrence, not when cash changes hands. Think about the case of depreciation expense which does not represent an outflow of cash at all.