Understanding Income Statements: Profit and Loss Made Easy

People, no matter what theirÃ?¯Ã?¿Ã?½ interests are or how they earn their living, should have a fundamental understanding of what the term “bottom line” means.Ã?¯Ã?¿Ã?½ Someone’s always talking about the “bottom line, but few people truly know what it means.Ã?¯Ã?¿Ã?½ :It comes from the business world.Ã?¯Ã?¿Ã?½ More specifically, it refers to a key financial document called the “income statement.”

Put quite simply, an income statement shows (1) how much money a company made from seling its product (or service) during a given time period (i.e. month, quarter, year, etc.); (2) how much money the company spent (during that same period); and (3) how much actually it earned for that period.

One of the first things that people should realize (and which an income statement clearly shows) is that “revenues” are not the same thing as “earnings.”Ã?¯Ã?¿Ã?½Ã?¯Ã?¿Ã?½ The two terms are used interchangeably by many people.Ã?¯Ã?¿Ã?½ However, they mean very different things. Ã?¯Ã?¿Ã?½ Revenues are the first line on an income statement.Ã?¯Ã?¿Ã?½ (Yes, they can be considered, in a way, the “top line,” in contrast to the “bottom line.”)Ã?¯Ã?¿Ã?½

The number in the “revenues”Ã?¯Ã?¿Ã?½ line shows just how much money a company received from its sales.Ã?¯Ã?¿Ã?½ From that amount, a company has to subtract all the money it spent to make the product (or service) it sold.Ã?¯Ã?¿Ã?½ Those expenditures are referred to as “the cost of goods sold.”
Consequently, subtracting that figure–“the cost of goods sold”–from the “revenues” figure, produces what’s called “the gross margin.”

Next, a company has to subtract from the gross margin its administrative and selling expenses.Ã?¯Ã?¿Ã?½ This category includes spending for such things as office rent, advertising, office supplies, etc.Ã?¯Ã?¿Ã?½ Subtracting the total amount of those expenditures from the gross margin, results in a number called “before tax profits (or loss).”Ã?¯Ã?¿Ã?½

Not surprisingly, from that number a company has to subtract the amount of money that it pays the government in income taxes.Ã?¯Ã?¿Ã?½ Doing soÃ?¯Ã?¿Ã?½ produces– at long last– the bottom line.Ã?¯Ã?¿Ã?½ In other words, the bottom line is “net income (or loss) after taxes.”Ã?¯Ã?¿Ã?½ Put another way, it’s the amount of money the company actually earned (i.e. its earnings for the time period covered by the income statement).Ã?¯Ã?¿Ã?½

Those earnings are what it gets to keep and use any way it chooses (i.e. invest in new equipment, pay in dividends to stockholders, etc.)

Therefore, the key thing to remember is that the bottom line refers to how much money is left over once you’ve paid all your bills.Ã?¯Ã?¿Ã?½ It’s the amount of money you can safely consider yours.Ã?¯Ã?¿Ã?½