Accounting
The Income Statement
A summary of what a business earned and spent over a period of time, ending in the bottom-line number: profit or loss.
Definition
The income statement (also called a profit and loss statement, or "P&L") is a summary of a business's revenue (money earned from its core activity) and expenses (costs incurred to run the business and generate that revenue) over a specific stretch of time — a month, a quarter, a year — ending in a single bottom-line figure: net income (a profit) if revenue exceeded expenses, or a net loss if expenses exceeded revenue.
Why this exists
The accounting equation is true at any given moment, but a moment-in-time snapshot doesn't tell you whether a business is thriving or struggling — a business could have grown its assets this year because it took out a large loan, not because it made money, and a snapshot alone can't tell the two apart. What most people actually want to know is simpler: over this specific stretch of time, did the business bring in more than it spent?
The income statement isolates exactly that question by tracking revenue and expenses over a period and netting them against each other. Because it's built on accrual accounting rather than cash accounting, it credits revenue and expenses to the period the underlying sale or cost actually happened in, not to whenever cash moved — so it reflects what the business actually did during that period, not just its bank activity.
This single number, net income, is also what flows into equity on the balance sheet: profit a business keeps instead of paying out increases what belongs to the owners, tying the income statement directly back to the accounting equation it started from. The balance sheet says what a business has right now; the income statement says how it got there over a stretch of time.
Formula & mechanics
At its simplest:
Net income = Revenue − Expenses
Expenses are usually broken into categories for clarity — most commonly cost of goods sold (the direct cost of whatever was actually sold, like ingredients in a bakery) and operating expenses (everything else it costs to run the business day to day, like rent, wages, and marketing) — but they all still subtract from revenue the same way to reach net income.
Worked example
Maria's bakery, for one month:
Revenue (cake and pastry sales): $20,000 − Cost of goods sold (flour, sugar, packaging): $6,000 − Operating expenses (rent, wages, utilities): $10,000 = Net income: $4,000
Maria's bakery earned $4,000 more than it spent this month. That $4,000, if she leaves it in the business rather than taking it out for herself, becomes part of the bakery's equity — the link back to the accounting equation.
Try it yourself
Net income
$4,000.00
Gross margin
70.0%
Operating margin
20.0%
Net margin
20.0%
How the math works
Revenue: $20,000.00 − Cost of goods sold: $6,000.00 = Gross profit: $14,000.00 (70.0% margin) − Operating expenses: $10,000.00 = Operating income: $4,000.00 (20.0% margin) − Other expenses: $0.00 = Net income: $4,000.00 (20.0% margin)
Each margin divides the profit figure at that stage by revenue, which is what makes it possible to compare this business's efficiency to one of a completely different size.
Common misconceptions
“Net income (profit) is the same as cash in the bank.”
Under accrual accounting, some revenue may not be collected yet and some expenses may not be paid yet. Net income measures economic profit for the period, not the business's current cash balance.
“A business with high revenue is automatically healthy and profitable.”
Revenue is just the top-line figure before any costs are subtracted. A business can post huge revenue and still show a net loss if its expenses exceed it.
“The income statement shows everything a business owns and owes.”
That's the balance sheet's job. The income statement only covers a period of activity — revenue and expenses — not a business's overall assets and liabilities.
Also in the Glossary: Cost of Goods Sold, Expenses, Income Statement, Net Income, Operating Expenses, Revenue