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"cost of sales", or something similar, which is the cost of the inventory sold. The difference between these two is called Gross Margin or Gross Profit. Then there are operating costs, like salaries and rent and telephone and income taxes and so on. After subtracting these from the gross profit, the result is the Net Income of the business. If it is positive, it is added to the equity, if there is a net loss, it is a subtraction from equity.

The income statement is a sub-set of equity really.

From a very basic standpoint, this is the essence of accounting. Things do get more complex as your business gets more complex and thins is why the footnotes on publicly-traded companies go on and on and on, seemingly forever. What these do is tell you what each of the entries mean on the balance sheet and the decision processed management had to go through to arrive at the numbers. They are the most important document in the financial statements, more important than the income statement or the balance sheet. They must be understood if you want to have any hope of understanding the business.

As your business grows, it will eventually have to have Audited Financial Statements either for a bank loan or investors, or both. An auditor is a special kind of accountant who expresses an opinion of the fairness of the financial information presented in the Balance Sheet, Income Statement, Statement of Cash Flows and Footnotes. The financial statements are created by and are the representation of management, not the auditor. The auditor's opinion means that the financial statements were prepared in accordance with Generally Accepted Accounting Principles ("GAAP") in all material respects. GAAP are those accounting principles which are appropriate to the specific business and are not always chipped into stone, but subject to some interpretation. The word "material" means something which would make a difference - whatever that is. Both of these things are the reason the footnotes must be read and understood.

There is, a whole lot more to know, and as I said before, the best way to learn it is through your own CPA, unless you just WANT to take an accounting class.

Learn more about this author, J L Petriesan.
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