The income statement is structured in a pretty standard manner, so documenting its parts is a simple exercise.

Revenue

This is the first item on the list. Revenue is a listing of the company’s methods of making money. Usually, a company makes money by selling something (Net Sales), but there are other methods too. For example, spare cash is invested in the stock market or loaned to other companies and so on. Some companies also get grants from the government, others rent out spare space, some put spare money in fixed deposits and so on.

So, the most important method of making money is Net Sales, and all the other routes of making money fall into the Other Revenue bracket. Together, they form the top line of the revenue statement, called Total Revenue.

My company, Assertion, sells communication security solutions. We really sell 3 different solutions: A full fledged security solution called CollabSecure, a perimeter security solution called SBC Security, and a legacy solution called OSP Compliance. Together, the sales of these solutions fall into the category of Net Sales. We also put the money we earn into Fixed Deposits - and that is called Other Revenue.

Let's consider an odd case: Banks. A bank makes money by lending money and earning interest. So, for the bank, the revenue is the interest portion of the loans it gives out. Its other revenue may come from other opportunities, for example, by selling life insurance to customers.

Here's another one: A textile manufacturer invests its surplus cash into other businesses, often taking ownership stakes in them. Over time, its profits from the core textile business decline but the money (dividends) from the other businesses it invested in becomes huge. If the textile business makes up 20% of the revenue of the company, and the dividends become 80%, the question therefore becomes: what is net sales and what is other revenue?

Expenses

Expenses form the bulk of the income statement and have a number of sections. The most common sections are:

• Cost of Goods Sold (COGS)
• Selling, General and Administrative (SGA)
• Depreciation and Amortization (DA)
• Interest expenses

Cost Of Goods Sold

The expenses that are necessary to produce the goods that the company sells. They are operational in nature, so capital expenditure is not taken into account. For example, the above mentioned textile manufacturer needs thread, fabric, and labor to produce the textiles that its sales people sell. The cost of the thread, fabric, and labor is COGS. The cost of the machinery that is needed is NOT included in COGS. The cost of hiring the labor is NOT included.

Here's a corner case: a SaaS company creates a software, hosts it on AWS, and then sells subscriptions. Is the cost of developers to be added to COGS? No. Is the cost of AWS to be added to COGS? The production AWS site, yes. The developer AWS site, no. Is the cost of support to be added to COGS? Yes.

In general, COGS needs to be directly connected to production cost. 

Note: Total Revenue - COGS = Gross Profit. Ideally, you'd want Gross Profit to be positive

Selling, General and Administrative

The expenses that are needed to run the company, enable sales but are not directly related to the production of the goods sold, fall into SGA. The cost of sales, marketing, business development, administration, operations, promotions, security… all these fall into the SG&A category. Office rent, utilities and so on also fall into the same category.

If someone visits my factory and ends up buying my products - its still SG&A.

If I hire contract labor, where do they land? Depends on what they do - is the contract labor being used on the factory floor to produce stuff? Then its COGS. Is the labor being used to clean up the factory floor? To cook food for the cafeteria? If so, it would be SG&A.

Depreciation and Amortization

To manufacture something, you buy machinery. The machines lose value over time, which is a loss for the company. This loss is depreciation. Some items depreciate faster than others. For example, if I buy a laptop, it will probably be less than optimal within 3 years. But if I buy an escalator, it will work for a decade - norms allow different depreciation values to be handled over time.

Amortization is different - it is the value assigned to intangible assets - copyrights, patents, licenses, goodwill and so on. In general, these remain steady or increase, but imagine a company going bankrupt because of its inability to pay suppliers - this would cause goodwill to decrease. Or copyrights/patents may expire. Thus the value may decrease.

Interest expenditure

Companies often take loans to fund certain work - some of it may be operational loans, and some may be capital expenditure. The company has to pay interest on those loans and that is marked out separately.

The Revenue Recognition Principle

Assume that you work for a company that demands payment in advance for rendering services. For example, maybe you build roads for villages - its both labor and cost intensive, with many small projects. Instead of taking bank loans and advances, you take payment on signing the contract and then deliver the roads over the next 3, 6 or 12 months. The question then is: when the money comes in, at what point do you add it to your income statement?

If you add the money as soon as it comes in, it boosts the revenue immediately, but the work has not been delivered, so is that appropriate? Failure to deliver may lead to the village demanding its money back.

More complicated - what if you get the order in Jan, get some advance in Feb and the bulk of the payment on delivery of the road, in June. Can you book the revenues in Jan itself? Or should you deliver it as and when the money comes in?

If you close your books in March, it would look great if the revenue is booked in Jan or Feb, because it boosts your numbers for the current year.

Because of this, there are clear rules about when revenue can be added to the income statement- and the rules emanate from the principle that revenue can be recognized when it is 'realized' or 'realizable and earned'.