What is an Income Statement?

0:06 welcome 0:07 in this video we're going to discuss the 0:08 income statement or the answer to the 0:11 second big question in life 0:13 i should probably remind you of what 0:14 that second big question is first 0:16 it's how well did the organization 0:18 perform during a given period of time 0:21 or what happened over time the income 0:24 statement was actually invented to 0:25 answer that question 0:26 people found they kept asking it over 0:28 and over again so they thought 0:30 maybe what we should do is create some 0:32 sort of a tool that will get at this in 0:34 a standardized way across a lot of 0:35 different companies 0:37 it gives us the flow of the value 0:39 changes for a specific period of time 0:42 so that we can answer this question of 0:43 how well did we do 0:45 now what do you need to know if you want 0:47 to answer that question 0:48 let's think of it from a common sense 0:50 standpoint first 0:52 you're asking yourself what came into 0:53 the firm 0:55 what did we have to use up to get that 0:57 to come into the firm 0:59 and then how much net value did we 1:00 create once this was all done 1:03 now if you've looked at an income 1:04 statement you haven't seen those words 1:06 because accountings have put them into 1:08 some sort of an accounting speaker 1:10 jargon 1:11 when we talk about what came into a firm 1:13 we call it revenues 1:14 and when we talk about what you've used 1:16 up we call that expenses 1:18 and when we put the two of these 1:20 together to figure out how much net 1:21 value creation you've had 1:23 we call that net income let me give you 1:26 a little more insight into what we mean 1:28 by some of these items 1:30 if you think of revenues a good working 1:32 definition of it is 1:34 value received from customers for 1:36 performing the company's primary 1:37 activities 1:39 that'll get you pretty much there but if 1:41 you look at what accounting guidance has 1:43 said 1:43 when they're trying to explain revenue 1:45 they get a little more complicated 1:48 they'll say revenues are inflows or 1:51 other enhancements of an asset of an 1:52 entity 1:53 or settlements of its liabilities during 1:56 a period from delivering or producing 1:57 goods 1:58 rendering services or other activities 2:01 that constitute the entity's ongoing 2:03 central operations 2:04 what do they really mean that we've 2:07 created 2:08 value through our primary business 2:10 activity 2:11 let's take a look at expenses we can get 2:14 a pretty good working definition there 2:15 too 2:16 expenses are value used up during the 2:18 period in order to create revenues 2:20 or fulfill other requirements of the 2:22 firm during this period 2:24 now again the standard setters have made 2:26 this a little more complicated 2:28 they tell us expenses are outflows or 2:31 other using up of assets 2:33 or occurrences of liabilities during a 2:35 period from delivering or producing 2:37 goods 2:38 rendering services or carrying out other 2:40 activities that constitute the entity's 2:42 ongoing central operations 2:45 again what they're really trying to get 2:47 at there is we've done something that's 2:49 used up value during this period and 2:51 we're going to call that an expense 2:54 now that we have definitions let's think 2:56 about how all this comes together 2:58 in an income statement we're going to 3:00 look at the basic format 3:02 income statements always start with 3:04 revenue at the top when people use that 3:06 phrase top line 3:07 that's what they mean how much revenue 3:09 did you have that's all the value that's 3:11 come into the firm 3:12 now what we're going to do is think 3:13 about all the expenses it took to create 3:15 that value 3:16 but on an income statement we're going 3:18 to break those expenses down into 3:20 different categories each of those 3:22 categories represents a group of 3:24 expenses that behave in a similar way 3:26 so the very first expense we think about 3:29 is cost of goods sold 3:31 those are the costs that are so directly 3:33 related to 3:34 generating the revenue that we think we 3:36 can match it up pretty closely 3:39 when we take the revenues and then we 3:40 take out the cost of goods sold 3:42 that leads to what's called gross profit 3:44 i'm sure that's a term you've heard 3:46 before 3:47 it's the gross profit because it's only 3:49 considering some of the cost 3:51 that we had to incur to generate the 3:52 revenue so it's 3:54 gross of those costs but we haven't 3:57 netted out the rest of them 3:58 what are those other costs well we've 4:01 got this category called 4:02 selling general and administrative 4:04 expenses 4:06 often people will call this sg a if 4:08 you've heard that term before 4:09 now you'll notice the very first word 4:11 here is selling so you're probably 4:13 asking yourself 4:14 well why isn't that in cost of goods 4:15 sold these may be selling expenses that 4:18 aren't quite as 4:19 direct for example in cost of goods sold 4:21 we would put all of the cost of 4:23 building the item we're going to sell in 4:25 selling we might put something like the 4:27 cost of the sales people who stand on 4:29 the floor 4:30 we're going to pay them the same this 4:31 period no matter how much they actually 4:33 sell 4:33 so it's not as direct as the cost of 4:35 goods sold 4:37 whether a firm puts a specific cost in 4:39 cost of goods sold or sell selling 4:41 general administrative 4:42 really varies with the firm's business 4:44 model we'll talk about this in some 4:46 other videos as well 4:48 but there's some judgment involved in 4:50 the geography of where things go on the 4:52 income statement 4:53 depending on how you think about your 4:54 business model now after we have those 4:57 selling general and administrative 4:58 expenses 4:59 we also have other operational expenses 5:02 you're probably asking yourself 5:04 what's left after the selling general 5:06 and administrative expenses 5:08 well it's other that's why others in the 5:10 name 5:11 again it really varies across companies 5:13 for example in most companies 5:15 they would put the cost of the 5:17 accountants who keep track of everything 5:19 and sell in general and administrative 5:21 expense 5:22 as accountants were part of the 5:23 administration but some companies might 5:25 say well those are other operational 5:27 expenses because they're 5:28 things that we're doing separate from 5:31 running the underlying business 5:33 now however they lump all of these 5:34 things once they've put together all of 5:36 these operating expenses 5:39 we come down to what we call operating 5:40 profit when you hear people use the term 5:43 below the line 5:44 this is usually the line they're talking 5:46 about this line item tells us 5:48 at this point these are the basic 5:51 profits 5:52 the net value that we've created from 5:54 the ongoing operations of our firm 5:57 now there's still expenses that go below 5:58 those though other incomes and expenses 6:01 this is things like our taxes that we're 6:03 going to pay 6:05 or some sort of expenses for a 6:07 non-typical item 6:08 once we take out those other expenses we 6:11 finally have this line item called gains 6:12 and losses 6:14 these are representing economic changes 6:16 in value of the firm 6:17 that don't come from ongoing primary 6:20 activities 6:21 and we'll come back to these in several 6:23 videos after 6:24 all of those items we finally come down 6:26 to that net income number 6:28 which represents the total value created 6:30 for the firm 6:32 now we're going to go back and in other 6:33 videos look at each one of these line 6:35 items in much more detail 6:37 but it's important for you to keep in 6:39 mind this overall structure of an 6:41 income statement when i talk about 6:43 geography and 6:44 you may hear other people use this term 6:45 or they may call it classification or 6:47 other words like that 6:49 what they're saying is in what part of 6:51 the income statement do we include a 6:53 certain cost or a certain value that's 6:55 come in 6:56 and the structure always pretty much 6:57 looks like this so that it gives you 6:59 some idea of 7:00 what your options would be now let's 7:02 move on to the more important part 7:04 once you have an income statement what 7:06 are you going to use it for 7:07 remember our goal is to provide 7:09 information to decision makers so the 7:11 income statement should provide 7:12 information 7:13 on important decisions well what if 7:16 you're asking a question like 7:17 how much did we sell during this period 7:19 the income statement would be great for 7:21 that 7:22 or what did it cost us to make sales 7:25 how much value did we create from our 7:27 core operations 7:29 what did it cost us to run our 7:30 administrative services this period 7:33 how much net value did we create as a 7:35 company 7:36 or how much interest did we incur during 7:38 this period 7:40 notice what all of these questions have 7:42 in common they're all talking about 7:44 some sort of value change that happened 7:46 over a specific period 7:48 anytime you're asking yourself a 7:50 question like that the income 7:51 statement's the right place to start 7:54 i hope this video has helped you 7:55 understand what the income statement is 7:57 good for 7:58 in the format of the income statement so 8:01 that you can better use it as a tool for 8:02 making decisions in the future