Phoenix Arizona CPA | Arizona Tax Accountant | Arizona Income Tax

Understanding Financial Statements. The term financial statements refer to a complete set of statements that include an income statement, a balance sheet and a cash flow statement. The Income statement (sometimes also called the Profit and Loss statement or P & L accounts) reflects the profit performance of a business. This statement summarizes sales revenue and expenses and reports on the profit for a period. The foremost thing to understand is whether the business has made a profit or loss and if so how much? Profit or loss is also usually determined for a specific period whether it be a month, quarter, half year or year.

Exhibit 1

Income Statement for the year.

Sales                                                               $          50,000

Cost of goods sold                                                  40,000             80%

Gross margin                                                             10,000

Operating expenses                                                  3,000                6%

EBITDA                                                                        7,000

Depreciation                                                               1,000

EBIT-Operating earnings                                          6,000                12%

Interest expense                                                            500

Tax                                                                                    600

Net Income                                                                   4,900         9.8%

The income statement is designed to be read on a waterfall concept. At the highest level, are the overall sales and other income for the business for a period. From this is deducted the Cost of goods sold. We follow the matching principle to match revenue and costs. This balance after deducting the cost of goods sold is the gross profit ort gross margin as it is sometime s called. From this margin operating expenses is deducted to derive the EBITDA. Operating expenses is all other expenses that are not part of cost of goods sold or those that are reported separately such as depreciation. This includes selling, administrative and other general expenses, legal expenses etc.This is an acronym for Earnings before Interest, Tax and amortization and Depreciation. This is an important number to measure profitability and compare different businesses in the same industry. Depreciation is a period charge for use of fixed assets. This is deducted from the EBITDA to derive EBIT. This is an acronym for Earnings before interest and tax. This also is an important measure for comparison, since eliminating interest and tax takes away the non operational items of expense in a business. Interest and tax is deducted to derive Net income.

Comparison of the items between two periods could provide an insight into changes that are happening in the business. Comparing the percentages also is an effective way to measure change.

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