Commonly Misinterpreted Accounting Terms: Income Statement Items
If there's anything that I've learned by doing technical accounting work over the past few months, it's that terms and terminology to make a huge difference in the information that's trying to be conveyed. Understanding the different terms is critical not only as the presenter of the information (because you want to make sure that you are representing the right thing) but also as a consumer of information (because you want to take away the right message). For those without a background in finance or accounting, the most commonly misinterpreted terms of the face of the income statement. unfortunately, these are the terms that are commonly used to measure a business's success and include terms like: revenues, net income, and gross profit, which each have a distinct meaning.
Today we're going to walk through these commonly misinterpreted terms so you can learn more about them and distinguish them in the next big headline or discussion you come across:
Revenues - Money brought in for the sale of goods or services. (Net Revenues represents the amount net of discounts and returns on products and services). Sometimes the terms “Revenues” and “Sales” are used interchangeably.
Cost of Sales (Cost of Goods Sold) - Costs incurred directly related to the generation of revenue. May include labor, materials, and applied overhead costs.
Gross Profit (Gross Margin) - Revenue less Cost of Sales - Represents the profit a company earns based on Sales and related costs alone, and does not include operating expenses (below)
Operating Expenses - Other costs associated with the operation of the company that don’t directly relate to the generation of revenue. May include administrative salaries, office rent, and other overhead.
Net Income (Loss) from Operations - Gross Profit less Operating Expenses - Represents the profit or loss from operations of the business, which includes both costs of sales and operating expenses
In addition to these items, some financial statements will also have line items for other income (such as investment and rental income), and provisions for income taxes, but these are the more common and more often misunderstood areas. For people who don’t read into financial information often, the key things to remember are:
Revenue is NOT Income
Gross Profit is NOT Net Profit
Different people will use different metrics for different reasons. For some, top line revenue is important because growing that top line amount is much more difficult than cutting costs, which could be done later. For others, consistent net income is important to ensure continued operation. So when someone is talking about how much revenue their business is making, be sure to ask them about their expenses so you get the full picture!