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About this lesson

Understand how business income and expenses are recorded and summarized.

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Income Statements
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Quick reference

Income Statements

The income statement (also known as the Profit and Loss report) is the report that tells the reader what the income and expenses are for a given date range. This report must be viewed either on a cash basis or an accrual basis. 

There are three components to the report:

  1. Income: money the business earns from selling its goods and services
  2. Cost of Goods Sold (also known as COGS): the direct cost of the goods and services the business purchased for a specific sale
  3. Expenses: funds spent to operate the business 

The names of the categories are called accounts, and the master list of all of the accounts is the chart of accounts. The business can choose the level of detail to use when identifying the account names to use, it does not need to match the tax forms that will be supplied to the IRS. Tax professionals are really good at Excel and will be able to combine similar accounts for reporting to the IRS.

The list of account names (chart of accounts) is not permanent and can be adjusted as the business’s needs change.

Cost of Goods Sold

Cost of Goods Sold (COGS) has a variety of similar names, including cost of labor and cost of services. A way to think about this section is to view it as the expenses that were paid as a direct result of a specific sale. 

Not all businesses will have COGS. If a business does not have expenses that are specifically and only for a single sale, there are no COGS. A business will likely need to buy things to provide services to its customers, if that purchase helps the business provide services to multiple customers, those are overhead or operating expenses. 

Expenses

Operating expenses are the expenses a business incurs when operating the business. Some of these expenses are fixed, such as rent. Others are variable expenses, such as utilities.

The income statement has a lot of flexibility. Accounts can be added and the report can be subdivided to meet the reporting needs of the business (such as showcasing the income and expenses for various departments or locations).

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  • 00:04 Income statements, a beginner's guide.
  • 00:09 I'm going to start with the question, what is an income statement?
  • 00:13 It's commonly known as a Profit and Loss Statement or profit and loss report.
  • 00:18 What it is though, is the report that presents the income and
  • 00:22 expenses over a defined period, meaning that it has a start date and a stop date.
  • 00:29 No matter which software you're using to prepare an income statement or
  • 00:32 to review an income statement, it has the same structure.
  • 00:36 There's income or sales at the top, cost of goods sold or
  • 00:40 cost of sales in the middle, and operating expenses on the bottom.
  • 00:45 I think it's easier to understand stuff if you can see it in action and see examples.
  • 00:50 I'm going to show you three examples.
  • 00:53 The first one will be using QuickBooks Online.
  • 00:56 I'm going to generate the income statement by selecting Reports on the left hand side
  • 01:01 of the screen and then going to select Profit and Loss from the Favorites box.
  • 01:07 QuickBooks has generated a Profit and Loss Report or an income statement.
  • 01:13 The top of the income statement is the income,
  • 01:15 all the different types of income that are tracked within this company file.
  • 01:20 Then there's the cost of goods.
  • 01:22 Down below are the operating expenses.
  • 01:26 At the very bottom, there's the net income or the net loss.
  • 01:32 When I scroll back to the top of this, you can see the date range,
  • 01:35 this is this year to date.
  • 01:38 The date range for it goes from January through November.
  • 01:42 The accounting method is cash or accrual.
  • 01:45 This report is based on accrual.
  • 01:48 I can change it to cash, choose run report, and updates the numbers.
  • 01:52 This is why it's important to have an understanding about the differences
  • 01:56 between cash and accrual.
  • 01:58 The next income statement I want to show you is from Xero.
  • 02:01 I'm going to go to Accounting at the top of the screen and then down to Reports.
  • 02:06 I'm going to select Income Statement on the right hand side from my Favorites box.
  • 02:11 We're now viewing the income statement.
  • 02:13 Across the top of the screen, you can see the date range selected.
  • 02:17 On the right hand side of the screen, if I select more,
  • 02:21 I can change the accounting basis from accrual to cash.
  • 02:25 As I scroll down, income is on the top,
  • 02:27 cost of goods sold is in the middle, expenses are on the bottom.
  • 02:32 And then at the very bottom is the net income or the net loss.
  • 02:37 The third software I'm going to demonstrate is FreshBooks.
  • 02:40 I'm going to select Reports on the left-hand side of the screen.
  • 02:45 In the lower right hand corner under Accounting Reports,
  • 02:48 I'm going to select Profit and Loss.
  • 02:52 I can see my Profit and Loss, I have my income.
  • 02:55 Cost of goods sold is not separated, it's combined with income.
  • 03:00 If there were cost of goods sold, we'd see them as a negative number.
  • 03:04 Beneath that we have our expenses.
  • 03:07 On the right hand side we have our filters.
  • 03:09 When I select the filters, this is where I can change it from accrual to cash.
  • 03:16 In each of these examples, you may have noticed that the income account names
  • 03:21 are different from each other, as well as the expense account names.
  • 03:26 I wanted to take a moment to point out the business gets to determine what
  • 03:31 income account names do they want to track and
  • 03:34 what expense account names do they want to track.
  • 03:37 I think this is best illustrated in the QuickBooks Online sample.
  • 03:42 The landscaping service company is choosing to track all kinds
  • 03:45 of different accounts.
  • 03:47 It's not right or wrong, it's part of the magic and
  • 03:50 flexibility of setting up your chart of accounts however you want it to be.
  • 03:55 So that when reviewing the income statement,
  • 03:57 you get the information that you need and want.

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