If you are a business personnel, you must be familiar with the term income statement. But do you know what an income statement is? Why is it important to keep a check on your finances? Why do you need to maintain an income statement? If not. Keep reading this article to learn everything about preparing your income statement.
An income statement is a financial statement that gives you a clear picture of your company’s earning and its expenditures. It is also known as a profit and loss statement (P&L) because it shows whether a business is making profit or loss in a given period.
Why is the income statement an integral part of your business that you need to update now and then? The reason is that it helps you to maintain the resilience of your small business. Maintaining an income statement along with a balance sheet and cash flow statement makes it easy for you to make a financial decision for your company. These financial statements are a vital tool to manage the progress of your business.
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Why Do You Need an Income Statement?
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How can you use an income statement to manage your business finances? Below you will come to know why an income statement is essential for your business. Profit and loss statement helps you keep an eye on the trends going on in your financial system. You can promptly decide if you are making profits or facing loss. An income statement will give you the following information about your business:
- Are you making enough profits to cover the cost of the products you are creating, i.e., revenue earned is higher than the cost?
- If you have more than one source of earning revenue, how are they performing? Which product helps you to make more profit or covers them cost-efficiently.
- An income statement also lets you know which sector you are spending most of your money on. Is it worth it for or should you reconsider your small business plan?
- The profit and loss statement also helps you filter out if there are any expenses that you can cut down to lower the cost and increase the revenue.
Preparing Your Income Statement
Other than these potential benefits, preparing an income statement can keep you updated about your business condition more often. All the other financial statements are maintained annually or bi-annually, whereas you can generate income statements monthly or quarterly. It helps you to pinpoint the areas you lack in and in which you need to improve your expertise.
Besides highlighting possible reasons to minimize your losses (if you are facing any), the income statement can show you growth opportunities. The profit and loss statement shows you the areas where your company is making huge revenue to spend more of your resources on that particular area.
Summing up, an income statement helps you to flag out potential sources of earning revenue and figure out potential areas that cost you more than they earn revenue for your company.
What Does an Income Statement Consist of?
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When you’re preparing an income statement or profit and loss statement gives you an overall view of your company’s financial health. For this reason, it needs to include extensive detail about financial prospects. The pattern of the income statement may vary a bit according to the company’s needs. However, it comprises of the following components:
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Revenue or Sales
The first component of the income statement comprises revenue. Revenue gives the information about gross sales made by the company in a specific period. Similarly, revenue can be of two basic types, i.e., operating and non-operating.
Operating revenue is the one a company earns by performing primary activities like manufacturing or providing services to its clients. In comparison, non-operating revenue is generated by non-core business activities, i.e., installation processes, operations, and maintenance.
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Cost of Goods Sold
The second principal component of an income statement is the cost of goods or services. You can explain it as the cost incurred in the process of manufacturing goods or services. This cost section includes only direct cost, i.e., cost of products sold. It doesn’t take in indirect costs.
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Gross Profit
Gross profit is the difference between net sales and the cost of goods sold. If gross profit is negative, it shows a loss, whereas gross profit’s positive value indicates that it is earning profits.
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Gains
Gains refer to any activity that brings in an increase in the income of the company. Likewise, gains include the money earned from activities other than regular business activities. For instance, sales of an operating segment, profit earned from onetime non-business activity,i.e., selling any old machinery, vehicle, or unused lands.
Difference Between Revenue and Gains
When you’re preparing your income statement, you have to know that revenue and gains are quite different. For instance, revenue is the profit earned from regular business activities, whereas gains are earned from selling fixed assets of the company once in a while. Gain is a rare activity of making a profit.
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Expenses
Expenses include all the expenditures company has to bear to generate revenue. It includes depreciation, wages, and all other payments. There are two types of expenses, i.e., operating expenses generated by carrying out necessary business activities and non-operating costs generated from non-core business activities. You need to take this into consideration when you’re deducting business expenses while filing taxes.
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Advertising Expenses
As the name shows, advertising expenses include costs required for marketing. Marketing expenses are carried out to expand the client base. Advertising expenses include all costs incurred in print media, online media, radio, and video ads.
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Administrative Expenses
Administrative expenses include the costs incurred to maintain its general health and overall activities. The administrative cost is not specific to any department. It consists of the salaries, office supplies, travel costs, and rent, etc.
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Depreciation
Depreciation is the cost of wear and tear of the machinery and fixed assets. It is a non-cash cost and distributed over the whole life of fixed assets. Depreciation shows the value of an asset used up by the company over a specific period.
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Earnings Before Taxes
Expenses before taxes measure the financial performance of the company. You can calculate expenses before taxes (EBT) by finding the difference between income and expenses before paying the taxes.
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Net Income
Net profit is the profit a company gets after deducting all the business expenses. On the other hand, net profit is the difference between total revenue and total expenses. Whereas net income, also known as net earnings, is the earning of the company. You can calculate it by subtracting sales and the cost of goods sold, taxes, and interests.
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