During the fiscal year, any organisation will have changes in its finances. The changes could be positive or they could be negative. But the senior management of an organisation will want to know the answers to questions like:

• How well are we doing financially?
• Are we earning a profit?
• Are we running at a loss?
• How is our profit in comparison to the competition?
• Are we likely to continue earning profit?

To answer these and similar questions, you can use an Income Statement.

Elements of the Income Statement

The Balance Sheet offers a snapshot of an organisation’s finances at one given point in time, the Income Statement looks at incoming revenue and outgoing expenses over a period of time. For the Income Statement we use the following definitions:

• Revenue – incoming assets in return for sold goods or services (cash or accounts receivable, for example).
• Expenses – outgoing assets or liabilities incurred (accounts payable, inventory sold or supplies used, for example).
• Net Income – the difference between Revenue and Expenses.

With all of this information, the Balance Sheet shows you whether you are generating a profit or you are operating at a loss.

The bottom figure on the above chart in is the Net Income. This is the difference between the organisation’s assets and its liabilities. It is the amount by which the equity of the organisation increases or decreases in a given period. This amount would also be recorded in an equity account, also called a Retained Earnings account, depending on the type of organization yours is. This takes us back to the Balance Sheet. Remember the sample Balance Sheet created for ABC Enterprises in the previous section? Here it is again. Notice where the Retained Earnings amount is listed.

It’s important to realize that just because the organisation has a positive Net Income for the month, that does not mean that they have that amount in cash available. Income can include more than just cash, such as interest earned from investments or financing could also be included as Retained Earnings. To know exactly what cash is still available at the end of the month, you would create a Cash Flow Statement.

What an Income Statement Tells You

The income statement tells you:

• The main sources of income earned
• Secondary sources of income earned
• Some information about the organisation based on the categories of revenue that are listed. For example, “Sales Revenue” tells you that the organisation sells a product or service, while “Fees Earned” would tell you that the organisation is a professional service provider of some kind.
• What items have no value left for the company because they are expenses– they will not generate any new income for the organisation
• Whether or not the organisation is operating with a loss or if they are operating with balanced revenues and expenses

What an Income Statement Does Not Tell You

An income statement does not tell you:

• Any prediction for future net income. The Income Statement is a historical document in the sense that it tells you what has already happened. It cannot be relied upon as a predictor of what will happen in future accounting periods.
• The exact amount of net income that was generated during the period the Income Statement covers. Even if the statement is very well prepared by the best accountants, it is impossible to accurately account for everything. For example, imagine that you spend R2,000 on a telephone marketing campaign to tell your clients or customers about an upcoming special you are offering. If you generate R8,000 in sales the next month, you cannot say that the marketing campaign generated that R8,000 in total. You may have some customers who would have come to you anyway– who might not have even seen the advertisement. Or, you might have customers that received the advertisement, but didn’t buy from you until the second or third month after the advertisement. The revenue for those sales would be attributed to the months in which they occurred, even if it was generated by efforts made several months before.
• Actual profit. Since revenues are not able to be fully, accurately reported in the accounting period, neither can profit be calculated to 100 percent accuracy. Plus, you also can’t calculate what is called True Profit. This is the difference between what expenses the organization has incurred and what assets have been invested
• The amount of cash on hand. As we mentioned before, Net Income does not mean cash. It only means the excess revenue over expenses in a specific period. Remember that incoming cash could be used for more investments or to buy more assets, or it could actually be received in a month other than when it was generated.