How to read an Income Statement?

Income statement is amongst the most important and frequently used financial statements in business decision making. Income is also known as "The Profit & Loss Statement". The basic purpose of making an income statement is to determine how the business has performed its operations. An income statement usually is made for a certain period. Strict financial regulations world wide have changed the way income statements are made. Earlier businesses use to make income statements for only a particular period, usually after a year. Nowadays business don’t follow this routine any more. Income statements are made every month, to keep track of how the business is performing. Income statement includes mainly two items. One is known as revenue and the other expense. Revenue tells us the earning the business had from its operations. Expenses usually tell about the expenditures made to achieve those revenues. There is also a very important and popular misconception in reading income statements. People usually are not able to understand the difference between revenue and income. Revenue and income are totally different things. Revenue is the income of the company from which no expense is deducted. Income on the other hand represents that portion which is surplus after deducting all the expenses made to achieve the revenue.



The visual outlay of different businesses income statements may be different but the bottom line remains the same. If the total revenue exceeds the total expenses i.e., Revenue > (greater then) Expenses then the company will have a surplus income. If for example Revenue < (less then) Expenses then the company will have a loss. Income statement is only complete once all the expenses are included. There are certain expenses which haven’t yet occurred but we have paid for them. These expenses do not belong to the current period under consideration. These types of expenses should not be made part of the income statement. There are then other expenses which have occurred for the month but we haven’t paid for them yet. They must be made part of the income statement as they represent the expenses of the accounting period under consideration.



Matching principle is one of the most important principles which govern the making of an income statement. This principle states that the expenses belonging to a particular accounting period must be catered for in that accounting period, it doesn’t matter we paid for them or not. For example we have a manufacturing firm whose electricity bill is $ 4,000 per month. It has an estimate that for the month of June it will have $ 4000 of electricity expense. The billing system is however not so perfect and the payment will be made after two months. This bill must be included in the income statement of June as this expense was made to earn the revenue for the month of June. Otherwise the income for the month of June will be overstated by $ 4,000 and the income for the month in which it was wrongly included will be understated by $ 4,000.