Introduction to the Income Statement

In the previous Carl was introduced to the major financial statements. He learned quite a bit about the balance sheet. Carl also had his first run in with the accounting equation: Assets = Liabilities + Owners’ Equity. Hopefully both you and Carl have a good understanding of the items discussed in the last lesson because they will be the building blocks for this lesson.

At the end of the last lesson you saw Carl’s Clockworks in action. Carl received financing for his business and he made his first sale (pretty exciting times). In this lesson we will see how Carl’s transactions affect the income statement.

A Story to Introduce the Income Statement

Carl, owner of Carl’s Clockworks, was recently invited to a local business owners’ event in his area. At first he was surprised by the invite (he wondered how anybody knew about his business considering he had only made one sale). However, while attending the meeting Carl found out that the old lady that bought all of his clocks was the leader of the local business chapter.

Carl brought his friend Peter (the accountant) to the event; he was feeling intimidated by all of the successful business owners in the area and thought that having a friend who understood how to speak business would be helpful. Boy was he right!

Massive success or huge failure?

Carl sat down next to a lady named Jillian at his assigned dinner table. The lady started to bombard Carl with questions about his business. With Peter’s help, Carl fumbled his way through most of the questions.

One part of their conversation was particularly intriguing. While appetizers were being served Jillian asked Carl what his revenues were this year. Carl really didn’t know what the word “revenues” meant and as he sat there looking to Peter for help, Jillian smugly said, “My company had over $10 million in revenues.” Carl choked on his cheese fries. Carl could only ever dream of having $10 million. Peter, on the other hand, was a bit more skeptical. He asked Jillian, “Well, what were your total expenses for the year?” Jillian’s smile quickly left her face as she mumbled something that sounded like “15 million dollars.” To which Peter responded, “In other words you had a net income or should I say net loss of five million dollars. Tough year eh?” Jillian got up and left.

After his encounter with Jillian, Carl decided that he needed to understand more about the language of business (accounting). How could someone have ten million dollars of revenue and still have a bad year? Carl was determined to find out and Peter told him the answer lies in the income statement.

In the next lesson Carl will learn what goes on the income statement.

Next Lesson: Lesson4.1 – What is an Income Statement?