Income Statement is Profit and Loss Statement

The profit and loss statement, also referred to as Income statement presents all of the company’s sales and expense during a given period (either a year or a quarter).

The profit and loss statement is presented in two parts:

• The first part is a summary, usually on a single page. Every item on it is a main item, with a series of sub-items listed in the second part.

• The second part, which usually takes up several pages, lists the series of sub-items and their contribution to the main item.

The summary statement is presented in a single column, and includes the company’s total sales.

All the other rows involve expense.

Every expenditure row is a main item for expense that share a given characteristic. Almost every expenditure row is followed by a subtotal row that lists the difference between total sales and the sum of all the expense above it. The bottom row of the statement is the net profit.

The Chess Pizza Company- Summary Profit and Loss Statement for 2008 (sums in $)

Explanation of the Items of the Statement

Sales:

This line sums all the company’s sales for all its products during the period. The sum also includes sales for which the proceeds have not yet been received.

Cost of Sales:

In the financial world, the word “cost” is used in place of the word “expense”.  This item is also referred to as “Cost of Goods Sold” (COGS).

Cost of Sales is an item that includes 4 main expenditure items with a very close connection to the products being sold: “Raw Materials”, “Salaries of Production Workers (direct labor)”, Wear and Tear” (“Depreciation”) and “Overhead costs”.

Cost of Sales is also called Direct expense, for the simple reason that it is very closely related to sales. If making a pizza requires 100 grams of flour ($1), 10 minutes of labor ($3), and 10 minutes in the oven ($0.50), then the cost of the “pizza elements” is $4.50 per pizza, and making 1,000 pizzas requires 1,000 pizza elements, costing 1000 x $4.50.

In the first (summary) part of the profit and loss statement, all pizza elements are included under the “Cost of Sales” main item.

The second part of the profit and loss statement lists the components of Cost of Sales.

The cost of Sales in the Examples:

In the small companies presented in the following examples, the cost of sales item will include only two elements: Raw Materials and Salaries. The other two elements (Overhead costs and Depreciation) will be ignored.

• Overhead costs are ignored for reasons of simplicity.
• Depreciation will be ignored until the meaning of the term is fully explained.

Selling Expenses:

The main sub-items in this item are Salaries of sales people, Advertising, Promotion etc.

General and Administrative (G&A) Expenses:

The main sub-items in this section are Executives’ Salaries, Building Maintenance expense (municipal property taxes, rent, etc.), Legal fees, etc.

These two items (selling expenses and G&A expenses) are also called Fixed expense, because they are less elastic, and mostly remain the same size (at least in the short term), regardless of whether sales are high or low.

Interest expense:

The main sub-items in this group of expense are Interest on Loans, Banking Charges, etc.

Income tax expense:

A company pays income tax on the sum listed in the row above this expenditure row (pre-tax profit before tax).

Subtotal Rows:

The names of all subtotal rows include the word “Profit” (Gross Profit, Operating Profit, Pre-Tax Profit befor tax, and Net profit).

The distinction between different types of profit is important in analyzing the company’s operating expense, as will be explained below.

When total expense are greater than sales, the company has a net loss.

In certain rare cases, the operating profit line or the gross profit line show a loss. In these cases, the row is called an operating loss and a gross loss, respectively.