The generic income statement below contains most of the elements found in a comprehensive income statement for a corporation. There’s certainly enough flexibility in the format to permit additions and subtractions based on the need to communicate business activity. In Chapter 1, we took a simplified approach to the income statement. The full income statement formula is an expanded accounting equation.

assets = liabilities + equity + revenues – expenses + gains – losses

Solving algebraically and then reducing it to the normal balance of each account yields the following:

assets + expenses + losses = liabilities + equity + revenue + gain or debits = credits

The income statement (Table 3-2) shows the profitability of the company.

The income statement is formatted with combinations of bold highlighting, indentation, preliminary account sums, and

Table 3-2. Income statement

aggregated category sums so the information is presented as clearly as possible. One of the few constants is that it will always show the company name, the type of statement, and the period being reported.

In this example, perhaps a small set design company, the Sales Revenue, the top line, is the money received from customers for the product. There are direct manufacturing costs involved and company records expenses for the raw material, the labor of the people who build the sets, and the overhead associated with manufacture. This overhead might be the shop where construction takes place as well as utility, insurance, and other costs associated with the defined work. Subtract these costs from Revenue to yield the Gross Margin.

Since this income statement calculates a Cost of Sales, General Widget (GW) provides a product. If GW were a service company, these costs would not appear. There are
variations in the income statement format depending on industry, company size, and disclosure needs. They will still follow the general sequence resolving debits and credits. Note also that this example classifies the income as it related first to production, the Gross Margin, also called “income from continuing operations.” Many consider this number the most important predictor of future business health. If it’s high, your business generates enough cash to support the activity that’s actually making money.

From the Gross Margin, subtract all the expenses incurred in “keeping the doors open” to yield Operating Income. This subdivision of the income statement is not a GAAP requirement, but it gives an idea of the strength and profitability of the core business operation. Then both expenses and income not related to operations are calculated. Often these are single-event items that will not recur—the tornado that took the roof or the obscure patent sold for big bucks. That brings us to Income Before Tax. We subtract the income tax and finally reach the bottom line, Net Income. This is how much we made. To know how well GW did as a company, you would have to compare this 7% return with others in the widget industry. It could be great, fair, or downright anemic.

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