Skills Development:

Financial Statement Introduction part 2 of 3

"If done accurately and timely, [accounting] is a very useful tool to tell us where we have been and where we are going."

Net Income = Revenues - Expenses

Technically all entries increase or decrease an asset, a liability or owner’s equity. However, in day-to-day activities there can be a few or thousands of entries. The objective of a business is to make a “profit”. The most important function of an accounting system is to provide information about the “profitability” of a business. A “profit” is an increase in owner’s equity. In order to tell whether or not a business is making a “profit” or is “profitable” these entries are summarized via an “income statement”. The “income statement” is made up of revenues and expenses.

Revenues are the proceeds from goods sold and services rendered to customers and are an increase in equity. Expenses are the cost of goods and services used up in the process of generating the revenues and are a decrease in equity. To determine net income we use the following formula:

Net income = Revenues – Expenses

Therefore, “net income” is the difference in excess of goods sold and services rendered over the cost of goods and services used up during a given period of time, (usually one month at a time for a total for 12 months or one year). The period of time covered by the income statement is referred to as the “accounting period.” Rather than make all entries in and out of the equity account, all these entries are summarized via the “income statement”. The income statement is used to evaluate the performance of a business by matching the revenues earned during a given period with the expenses incurred to obtain those revenues.

Training Pros International
Income Statement
For the Year Ended December 31, 20xx

Sales		$200,000
Cost of Goods Sold		120,000

Gross Profit on Sales		80,000
Operating Expenses:
Salaries	$36,000
Advertising	8,000
Telephone	1,000
Depreciation	4,000
Insurance	1,000

Total Operating Expenses	50,000

Net Income		30,000

Revenues are not necessarily cash receipts nor are expenses necessarily cash outlays. GAAP requires a “matching principle” where we must match the revenues generated within an accounting period against the expenses of generating those revenues. Therefore, since it not just cash collected or expensed, revenues and expenses are “accrued” to reflect what was earned or expensed, regardless of when paid or collected.

The balance sheet shows the financial position of a business at a point in time, a date. The income statement shows the results of operations over a period of time, the accounting period. As stated earlier, other names for the income statement are statement of operations, earnings statement, and profit and loss statement, or P & L for short. The most common name is income statement.

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