Is your business profitable? The only method to know your business’s financial health is to create an income statement. But let us look, why income statements are so important in the first place to run your business with commercial success?
What is an income statement?
Financial statements also known as Income statements showcase the profitability of a business over a period of time. It shows your expenses, revenue, profit, and loss.
At times, referred to as a “net income statement” or a “statement of earnings”. Income statements are amongst the three most essential financial statements in accounting, alongside the balance sheet and the cash flow statement.
While an income statement is only made for a business’s internal use, it will be referred to as P&L (Profit and Loss) statements.
The income statement helps you in understanding the financial health of your business.
Why is an income statement important?
An income statement assists the business owner to make profitable decisions for the company. Be it generating a profit by increasing revenue, or by decreasing cost, it showcases the effectiveness of the strategic plan built at the beginning of the business.
The team can refer to this statement to analyze whether or not these strategies have paid off and are they working in the right direction. However, they end up coming to the best solution based on their analysis.
Income statement resides some other things, which are as follows:
1. Frequent Reports:
Whilst other financial statements are released annually, the income statement on the other hand is generated quarterly or monthly. Amid this, business owners and investors can keep a track of the business’s performance from close and make profitable decisions. This even leads to finding any shortfalls and fixing small business problems before they grow and become expensive chaos.
2. Tracking Down Expenses
This statement mainly highlights the expenses or any unexpected expense for the future which are sustained by the company. Along with the domains that are under or over budget. Expenditures generally include rent, payrolls, salaries, and other miscellaneous expenses. These expenses even involve promotion, marketing, hiring a workforce, and providing amenities.
3. Business Analysis:
Investors get an overview of the business’s status in which they are investing through this statement. Banks and other financial institutions can analyze the statement to decide whether the business is worth investing in by calculating the company’s market value, loan credibility, and profitability.
Who uses an income statement?
The Income statement is used by two main groups of professionals: Internal and external users.
An internal group of users mainly include the management and the board of directors who use this data to track the business financial position in the market and fix the shortcoming if any.
These statements are even used to make decisions for commercial success, plus can take actions on any concerning financial transactions.
An external group of users mainly include creditors, investors, and peers. These external users are the ones who can actually provide you the source and direction to move forward.
Investors tally the company’s market position, growth, and profitability strategies for the future, to decide whether or not to invest.
Creditors on the other hand analyze the income statements to check the cash flow to see the credit eligibility of the company and will it be able to pay off the loans or in a position to get an additional loan.
Peers are the vital group of people who set a bar in the market. Peers or competitors use your income statements to fetch details of your company to tally the success parameters of a business and understand the areas of business expenditures and where all they are spending extra.
Components of an income statement?
The format of a business’s income statement varies depending on the regularity needs, business requirements, and operating activities associated with business operations.
Revenue and sales:
This is the topmost section on the income statement which offers a summarized outlook of gross sales made by the company. Revenue can be differentiated into two main categories: operating income and non-operating income.
Operating revenue is the revenue earned by a company through primary activities including, manufacturing products or services provided.
On the other hand, Non-operating revenue is earned by activities such as operations, maintenance, or installation.
Cost of goods sold:
Total cost of goods or services sold, is known as cost induced to manufacture the same. Keep note that it only comprises the cost of sold products. The cost of goods sold doesn’t generally include an indirect cost.
Also defined as net sales - the total cost of goods sold. Net sales are the total amount of money earned from goods sold, whereas the cost of goods sold is the money that you spend in producing those goods.
The result of an event leading to an increase in the organization’s income. Gains stipulate the amount of money registered by the company from different activities, including sales. The profit earned from non-business activities is also counted as gains.
For example, selling an old vehicle or land from a company, etc., all are the gains for the business.
However, gains are considered secondary revenue, both the terms are different. Revenue is the money that the company received on a regular basis whereas, the gain can be deemed from the sale of fixed assets which is generally considered as an activity that doesn’t take place that often in a company.
The cost a company has to bear in order to generate revenue is considered an expense. Employee salaries, payments, and equipment depreciation are expenses that the company incurred.
Operating and non-operating expenses are two main categories of business expenses.
For example, pension, payroll account, sales commission are operating expenses. Expenses caused by the company’s basic operations are operating expenses.
Whereas, the expenses which are not caused by core activities are known as non-operating expenses. These expenses include lawsuit settlement or charges for obsolete inventory.
The marketing cost to grow your clientele are simply the advertising expenses. They comprise advertisements on social media and print as well as television ads, and radio advertising. Advertising costs are part of Sales, General & Administrative expenses.
The expenditure incurred by the company rather than associated with any specific department of the business. Salaries, rent, supplies for the office, and travel allowance expenses. Administrative expenses are considered as a fixed expense and exist at all levels of sales.
Distributing the cost of an asset in the long-term over its useful life span. It is the managements’ responsibility to write-off the depreciation value of the asset but it is known as a non-cash transaction. Depreciation mainly showcases the value of an asset used by the company over a period of time.
EBT (Earnings Before Tax):
The company is measured by its financial performance. EBT is calculated by deducting the expense from income, before taxes. This is amongst the line units on a multi-step income statement.
Defined as the total amount of money earned after deducting general expenses of the business. Total expense minus total revenue is the net profit of the company. Whereas, gross profit can be known as the money that company earns after subtracting the cost of goods sold which is defined as the company’s earning that is net income.
Single-Step Income Statement
A single-step income statement is the simplest form of the income statement, where you put the values of expense, income, gains, and losses into the simple equation of net income, that is, Net Income = (Revenue + Gains) - (Expenses + Losses). Hence it is based on simple calculations, it is known as a single-step income statement.
From the above example, you can see that the cricket association earned $35,000 from the sale of goods and another $5,000 by charging for training. The association spent money on various activities, to arrive at total expenses of $18,450. They gained $2,000 by selling an old van, while facing a loss of $1,000 for settling a pending consumer lawsuit. Now, to calculate the net income, let us enter the values in the following equation:
Net Income = (Revenue + Gains) – (Expenses + Losses)
= (40,000 + 2,000) – (18,450 + 1,000) = $22,550
Multi-Step Income Statement
Global companies operating on a huge level with a wide range of services and goods as well as involved in partnerships and acquisitions have to follow a complex way of maintaining the income statements.
Due to such a wide range of activities involved, they have to comply with precise reporting methods. These companies go for multi-step income statements, in which operating expenses, operating revenues, and gains are classified separately from non-operating expenses, non-operating revenues, and losses.
They follow a four-level structure while preparing the income statements which involves: operation, gross, pre, and post-tax.
An income statement is a vital source of information about the business’s financial position and the key factors responsible for its profitability. It offers you timely updates as it releases much more information on frequent time periods than other statements.
The income statement showcases the expense, income, losses, and gains of the company, which can be easily calculated by mathematical equations to get the net profit and loss for a given period.
This data helps you to make profitable decisions as well as build and restructure your strategic plans for making your business a success.