How to Create an Income Statement for Your Business?
In continuation of our series on “Accounting Basics for Startups”, in this article, we would converse in detail about ‘Income Statement’ or what is commonly referred to as ‘Profit and Loss Account’. Need to Prepare Income Statement (Operational Efficiency Statement)
The Income Statement as the name suggests, indicates the operational efficiency of the business through its internal operations. It is one of the major financial statements relied on by accountants, business managers, investors, lenders, and parties related to the business. Some of advantages of Income Statement are listed below:
- Provides actual information about net profit or net loss of the business for a desired financial period
- Facilitates comparison of net results of business on two dates and ascertains its progress
- Preparation and analysis of income statement helps in developing cost control techniques to reduce indirect expenses
- Net profit of various years helps the business in allocation of resources and operational expansion
- Facilitates establishing price strategies by constantly evaluating the prices set for the firm’s products and services.
- Serves as basis for preparation of Cash Flow Statement.
- Facilitates in calculation and analysis of financial ratios and tools for better management of business.
Basic Terms used in Income Statement
Let’s first get acquainted with some basic terms to interpret the transaction of a income statement.
Sales: Represents the amount of revenue generated by the business. The amount recorded here is the total sales, less any product returns, sales discounts and other allowances.
Cost of goods sold or cost of sale: Represents the costs directly associated with the manufacturing of the product or rendering of services. It includes materials purchased; direct labour as well as any internal expenses directly expended in the manufacturing process.
Gross profit: It is derived by subtracting the cost of goods sold / cost of sales from net sales. It does not include any operating expenses or income taxes.
Operating expenses: These are the expenses that constitute the entity's ongoing major operations. It is divided into selling, general and administrative expenses. Selling expenses include salaries of sales people, commissions and travel expenses, advertising etc. General and administrative expenses include salaries of officers / executives, legal and professional fees, utilities, insurance, depreciation of office building and equipment, office rents, office supplies, etc.
Depreciation: It is a charge against fixed assets / intangible assets used in your business.
Other overhead costs: These include insurance, office supplies, cleaning services etc.
Non – Operating Expenses: These includes interest expenses, bank charges, foreign exchange loss, and all other finance costs.
Net income before taxes: This number represents the amount of income earned by a business prior to paying income taxes. This figure is arrived at by subtracting total operating expenses from gross profit.
Net income: The net income that arises after accounting for income tax is the actual earning of the businesses.
EPS (Earnings per Share): It is required to be disclosed on the face of the income statement. It is important because it suggests the value of the company’s share in the market. It basically emphasizes on the value generating capacity of the company for its stakeholders.
Methodology for Preparation of an Income Statement
The Profit & Loss statement or Income Statement basically summarizes the revenues and expenses for a period by recognizing revenue and charging cost and expenses against these revenues for a specific period. A standard template of a trading business for better clarity and presentation of transactions is being provided below:
The income statement can be prepared in one of two methods, namely (i) Single Step (ii) Multi-Step Income. Single step involves summarizing the revenues and subtracting expenses in aggregate to find the net income of the business. But organizations prefer Multi-Step income statement, wherein expenses are segregated into operating and non – operating expenses and when deducted from gross profit yields income before taxes.
Thus, we have tried to explain the basics of income statement in an abstract way, as the topic is so broad; it’s not feasible to cover all in one article. Nevertheless, Income Statement is most important decision enabler financial statement, which any business, especially a startup cannot afford to neglect.
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