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The INCOME STATEMENT Explained (Profit & Loss / P&L) - YouTube
Channel: Accounting Stuff
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in this video you'll learn what's an
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income statement is I'll show you what
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it looks like and how you can use it to
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measure a business's financial
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performance hey there welcome back to
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accounting stuff I'm James and in
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today's video we're going to cover the
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income statement also known as the
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profit and loss statement or the P&L for
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short this is one of the three major
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financial statements in accounting along
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with a balance sheet and the cash flow
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statement collectively these reports
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give us an impression of the business's
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financial health so it's important that
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we understand how they work I've already
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made videos covering the balance sheet
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and the cash flow statement which you
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can find linked up here and down below
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in the description but up until now I
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haven't posted a video yet on the income
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statement and I've received a lot of
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requests from you guys to cover this
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topic so thanks for all these
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particularly from one subscriber so Nili
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if you're watching this video goes out
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to you good luck in your exam hope you
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crush it an income statement is the
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summary of a business's revenues and
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expenses over a period of time in his
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basic form an income statement looks
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like this it's a summary of a business's
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revenues and expenses over a period of
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time when we take our total revenue and
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subtract our expenses from it then we
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work out our profit or our loss we make
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a profit when our revenues exceed our
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expenses and on the flip side we make a
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loss when our expenses are more than the
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income we've earned this is why the
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income statement is also known as the
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profit and loss statement or the P&L for
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short it lays out a roadmap for how we
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ended up here at the bottom line our
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profit or loss the income statement
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always covers a period of time which
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could be anything that we wanted to be
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but typically we run it for a month a
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quarter or a full year here's a hopeful
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analogy that I read in this book the
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accounting game which I recommend
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reading if you're new to accounting you
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can find my review of it up here
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back to it if a balance sheet shows us a
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snapshot about business's assets
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liabilities and equity at a single point
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in time then you can think of it as a
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photograph or a still frame taken from a
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video whereas the income statement
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covers a period of time it's like
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watching a clip of that video it has a
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beginning and it has an end and if we
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look at it carefully and analyze it then
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it can tell us a story but more on that
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later let's take a closer look at our
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income statement revenues less expenses
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make us a profit or a loss the problem
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with this layout is that it doesn't give
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us much detail it would be much better
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if you made things a little more
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descriptive for instance revenue there
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are many different types of revenue if
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we were running a business that sells
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physical products then we might want to
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call this product sales instead or if we
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provide services we can call this our
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services rendered this extra detail
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hopes the readers of the income
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statement better understand what they're
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looking at clarity is that a movie game
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here the same goes for expenses
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businesses typically incur many
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different types of expense but broadly
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speaking these can be broken down into
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two categories or direct costs of doing
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business and are indirect costs of
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running the business or direct costs of
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doing business are the costs which we
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can directly trace through to the
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products we've sold or the services that
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we've provided for a business that
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provides services we might call this our
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cost of services and if we sell physical
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goods then we can call this our cost of
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sales or our cost of goods sold direct
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costs like these are variable costs
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which increase in direct proportion to
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the sales that we've made if you were
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running a retail or a wholesale business
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then these would include things like the
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original purchase price of the product
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that you're reselling or if you've run a
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manufacturing business then this would
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include the cost of your raw materials
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or the direct labor cost that went into
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producing your product as we make more
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sales we incur more
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of these direct costs cost of goods sold
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can be a bit of a tricky concept to
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understand at first it ties in very
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closely with inventory in the balance
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sheet if you'd like to see me make a
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video explaining how all of that works
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then let me know down below in the
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comments and if you haven't already
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remember to hit that subscribe button so
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you don't miss out on all of the other
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accounting tutorials that we have coming
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out very soon back to the income
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statement when we take our revenue and
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deduct our direct costs of doing
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business we get to our gross profit if
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you're new to accounting then you'll
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soon discover that we have many
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different types of profit our gross
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profit is a really useful tool that
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allows us to measure the efficiency of
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our production and sales process I'll
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show you how that works in a minute but
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first let's jump back to indirect costs
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these are the costs of running a
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business which can't directly be traced
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back to the production of goods or the
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provision of services we sometimes call
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these overheads overheads can include
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fixed costs like rent employee salaries
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insurance costs admin expenses legal
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costs accounting costs marketing costs
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depreciation and amortization for
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there's a lot of them fixed costs like
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these tend to remain the same they bear
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no correlation at all to the sells that
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your business has made however not all
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overheads are fixed variable overheads
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can loosely correlate with a business's
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sales although they can't be directly
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traced back to the production of goods
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or the provision of services these
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include things like advertising costs
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which can indirectly drive sales and
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sales commissions utility costs could
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also be considered a variable overhead
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in a manufacturing business because
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these can increase as we've ramped up
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production when we deduct our indirect
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costs of doing business from our gross
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profit we come to our operating profit
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operating profit measures the net income
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that we've generated from operations
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this is the residual amount that's left
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over after deducting all of our direct
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and indirect costs of doing business so
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this is our basic income statement but
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how does it help us measure a business's
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financial health it does that by giving
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us a means to compare our financial
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performance against comparative
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accounting periods a comparative period
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is a different period of time it can be
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whatever we want it to be we can compare
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a current month income statement against
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last month's income statement or this
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year versus last year when we use
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comparative periods we can calculate the
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change or movement across each line item
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down the profit and loss statement and
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as accountants it's our job to support
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these movements with a narrative which
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explains all of the differences let's
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throw in some numbers into an imaginary
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company and I'll show you what I mean
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we'll compare the movements in our P&L
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year-on-year this is going to be for a
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medium-sized business so we can quote
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our numbers in thousands of dollars what
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have we got here our imaginary company
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has made sales of a hundred and ten
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thousand dollars which is up ten
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thousand dollars from what we made in
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the prior year our cost of goods sold
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have also increased by ten thousand
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dollars from $30,000 to $40,000 that's
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left us with a gross profit of seventy
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thousand dollars which has remained
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unchanged our overheads are fixed at
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forty five thousand which gives us an
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operating profit of twenty five thousand
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dollars in each period what can we learn
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from all of this well our sales have
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increased by ten thousand dollars but
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our gross profit has remained exactly
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the same how can that be a useful metric
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that we can use to analyze this is gross
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profit margin we can calculate our gross
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profit margin by taking our total
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product sales and deducting our costs of
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goods sold and then dividing the whole
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Lots by our product sales this measures
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how efficiently we've been producing and
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selling our imaginary product in this
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case our gross profit margin in the car
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here is around 64% which is actually
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down from last year's gross profit
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margin of 70% how is that possible well
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one of two things could be happening
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here our sales can be shrinking or our
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costs could be rising we could be
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selling more products but at a discount
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or the cost of our raw materials could
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be rising these are the questions that
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we need to be asking ourselves as
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accountants investors or small business
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owners we can compare metrics like the
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gross profit margin across comparative
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periods to help us identify what
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questions we should be asking and then
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that's when the work begins we need to
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find out the answers and use them to
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build a narrative that explains what's
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going on gross profit margin is just one
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of many business metrics that we can use
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to analyze the income statement if you'd
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like to see me make videos on the others
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let me know now this is still quite a
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basic income statement in reality there
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are other indirect costs of doing
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business which we might need to include
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as well things like interest expenses
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and tax these tend to slot in the lower
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operating profit because they aren't
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considered to fall within the normal
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cost of operations this is why operating
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profit is also known as EBIT or earnings
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before interest and tax when we deduct
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her interest in tax from our operating
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profit we calculate our net profit the
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bottom line because it's at the bottom
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of the profit and loss statement so you
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can see that there are many different
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types of profit and loss to consider in
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accounting we start off with our revenue
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and we deduct our direct costs of doing
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business to come to our gross profit of
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top-line profit below this we take out
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the indirect costs of running our
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business to find out operating profit
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our EBIT our earnings before interest
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and tax and when we remove interest and
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tax we calculate our net profit the
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bottom line together these different
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types of profit help us measure
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performance over a period of time the
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main goal of most businesses is to
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maximize their profits so it's important
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to be clear on what that means and to be
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aware of the differences between gross
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profit
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operating profit and net profit which
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can each tell us a different part of the
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story like I mentioned earlier the
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income statement is just one of the
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three main financial statements along
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with the balance sheet and the cash flow
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statement I've made videos covering both
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of these already which you can find here
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and here if you found this one useful
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give it a like or better yet share with
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a friend why not don't forget to
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subscribe for more accounting tutorials
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I'll see you around
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