The income statement (profit and loss statement) is the oldest financial statement and simply compares revenues and expenses over a period of time to show the firm's net profit or loss. The income statement may be figured on a day, week, month, quarter, or yearly basis. This generally shows the accounting profits or losses of a business because it records the revenues minus the expenses. Once expenses are deducted from the business revenue, the result is profit (or loss) for this specific time period.

The income statement is developed on an annual basis to illustrate the financial activities of a franchise headquarters' organization for the total fiscal year of operation. It is often compiled on a monthly basis to illustrate the profit and loss generated by the headquarters' organization for that time period. The income statement first identifies the revenues followed by expenses yielding a net income before interest and taxes and then, following the deduction of interest and taxes, a net profit or final net profit is developed.

The revenue or income statement includes all sales, fees, or revenues received by the franchisor for the general business operation. These revenues generated by normal day-to-day business activities are considered "operating income." This income generally refers to initial franchise fees, royalties, and other fees received for services rendered (advertising fees are generally kept separate by the franchisor because they may only be expended for advertising or marketing functions of the franchising organization).

A "cost of goods sold" account is equal to the amount of "goods available" less inventory at the close of any accounting period. The costs of goods sold are simply the expenses involved in purchasing inventory which was sold during that time period.

When the costs of goods sold are subtracted from revenues, a gross profit or gross margin is developed. This is the business profit before expenses, interests, and taxes. Gross profit is used to compare financial performances over time or for preparing financial performances of different franchising units in a specific time.

Franchisors generally divided their operating expenses into three major classifications:

(1) general/administrative

(2) selling

(3) operations

The general/administrative expenses are those expenses the franchisor uses for operating the main headquarters including salaries, wages, benefits, and insurance. The selling expenses are costs directly associated with selling the franchise units to prospective franchisees. The operations expenses are those expenses involved in the support of the operations of the franchisee including training, rent, supplies, car expenses, delivery expenses, and staff support services.

The net income before interests and taxes is developed by subtracting the operating expenses from the gross margin. This shows what each franchise unit earned during a given period of time.

Generally all businesses have to pay some form of tax. These taxes are subtracted from pre-tax earnings when a business is a corporation -- which almost all franchisor organizations are. Taxes paid are generally based on applicable federal and state laws and regulations. Interest paid on a principal amount which has been borrowed to produce a business revenue is tax deductible. Interest payments are generally envisioned as the highest form of debt which the firm must pay when due. Debt service is very important to income statement analysis.

The final profit or "net" profit of the business is represented by the sum of all revenues minus the sum of all expenses and yields a net profit for the franchising organization. This is the amount of earnings available which may be used to pay dividends to stockholders, provide bonuses, reinvest in the business, provide additional support for franchise systems and provide possible new products/services research. The net profit is an overall measurement of the performance of the franchise over a period of time, generally on a monthly, quarterly, or year's performance basis.