In this article, we discuss the issue of an income statement, which is of great importance in the accounting processes of businesses and to see the financial status of the company and to determine the company’s future strategies accordingly. Firstly, we will examine a few examples of the income statement as well as the basic questions such as what is the income statement, which items the income statement consists of, and how the income statement is prepared.
What is an income statement?
The income statement definition actually includes income and expenses. where the business revenues + items are displayed as business expenses – expenses. When we create an income statement, we can find out if the business is profit or loss by looking at its result. Briefly, the income statement is a statement of profit and loss.
The income statement is one of a company’s basic financial statements,
Other utterances: profit and loss statement, statement of earnings, statement of operations,
Businesses are established with the aim of making a profit. The success of a business depends on its profitability to survive financially. If you are doing a simple job selling several types of products, you can calculate whether your company is making a profit or not by looking at the amount of money that comes in and out of your pocket.
However, today’s businesses have a much more complex structure and there are many factors that affect your profit and loss, other than buying and selling goods. For example, you sell a product you bought to 5 units to 8 units. You sold 1000 of this product in a month. Do you have only one input and one output? Of course, no. There are taxes, rental costs, employee salaries, electricity, water, heating costs, and more, all of which are costs. The income statement is the report and balance sheet of an enterprise.
Income Statement vs Balance Sheet, what’s the difference?
Income statements and balance sheets are often confused. Let’s simply show the difference.
The income statement shows that an enterprise’s income and expenses are listed for a certain period (for example, between 01.01.2020 and 31.12.2020), and, depending on the figures that appear, the company has made profit or loss in that period.
The balance sheet shows the assets of a business as of 31.12.2020, (end of the fiscal year) 31.03.2020 (end of the quarter) as of a certain date and with which resources these assets are covered.
The income statement is the first key of the financial statements, others are; balance sheet and statement of cash flows. The income statement also divided into three-part as following: “revenues”, “expenses”, “profit or loss”
How to Prepare the Income Statement
The income statement shows you how your income and expenses are realized over a period of time. Balance sheets show the assets of a business at a specific time. So we can say that The balance sheet tells you where you are, while the income statement tells you how you got there.
Income statements can be arranged in a report type or account type suitable for financial analysis. Obviously, in many countries of the world today, there are problems in terms of the accuracy and consistency of the information in its content, as the income statements are prepared through accounting programs and how they are prepared.
How the income statement and other financial statements work together
The income statement shows you how your income and expenses are realized over a period of time. Balance sheets show the assets of a business on a specific time. So we can say that, The balance sheet tells you where you are, while the income statement tells you how you got there.
Thanks to the cash flow table, you can keep track of your current cash information and where the cash came from. It is important to carefully prepare and update your 3 tables in order to map your company’s financial progress, analyze your current situation and plan the future well.
The cash flow chart allows you to keep track of your current cash information and where the cash came from. You will be informed about the instant status of your accounts for your cash expenses.
Simple Income Statement Example
In the picture you see below, I showed the parts that should be in the income statement in the basic sense. There are other refractions (details) under each section. However, when it goes to your head in this state, the work is finished. Income and profits are shown in blue, expenses and losses are shown in red. We will go from item to item on the far left. Normally, those figures do not appear in the income statement. I will only use it for an explanation.
1 – Revenue / Sales
The first item of income statements is the revenues that the company receives. During the period covering a certain period, for example, 1 month or 1 year, the sum of the sales is written here. You may be selling a product or giving a fortune, you must collect the unit of your product, for example, the number and corresponding revenues.
2 – Cost of goods sold
The cost of the goods sold is written as “COGS” based on the initials. If you are selling a good or service, it must have a cost, but you cannot write any costs to this item, its content consists solely of direct costs, such as raw materials, labor and shipping costs. For example, if you run a restaurant, you can write down the materials you use to cook, your employee expenses, and the shipping costs you make to bring food to your business.
3- Gross profit
When you subtract the total cost of the goods sold from the first item, the income item, you find gross profit. However, this figure alone does not mean anything. It just gives you an idea of how efficiently your company is running before adding overall costs.
4- General expenses
Also sometimes referred to as “operating expenses,” these include rent, bank & ATM fee expenses, equipment expenses, marketing & advertising expenses, merchant fees, and any other expenses you need to make to keep your business going.
These expenses are listed individually here, but some income statements will bundle these and other similar expenses together into one broad category called “Selling, General & Administrative Expenses” (SG&A).
General expenses also known as operating expenses. Many expenses are classified as general expenses such as your rental expenses, money transfers and bank expenses arising from other banking transactions, equipment expenses used in your business, marketing and advertising expenses.
These expenses are often grouped under the main classes, for example, while expenses arising from banking transactions are a group, marketing and advertising expenses are listed as a separate group. However, in some income statements, you may appear under the name of “Sales, General and Administrative Expenses” (SG&A), that is, firms can write these expenses without classification in the general expenses section of the income statements.
Earnings before Interest, Tax, Depreciation, and Amortization. EBITDA
Generally, EBITDA, do not present in income statements. EBITDA stands for Earnings before Interest, Tax, Depreciation, and Amortization. It’s calculated by subtracting the selling, general, and the administrative expenses from gross profit. This line is not included in the table above. We only mention it as additional information.
5- Operating earnings – Earnings Before Interest and Taxes. (EBIT)
The section in which these charges fit, is generally after the internal costs under our control are calculated. For example, the raw materials and products we purchase, labor costs, marketing costs, transportation costs, etc. include the cost items we can control less.
eg taxes and interest payments. Accountants sometimes define these items as operating profit or operating income.
6- Interest expense
If your business owes a bank or financial firm, it will pay it every month with an interest. The interest expenses should be recorded for the interest expenses which is direct should pay to your creditors It’s recorded in interest expenses side of your income statement.
7- Earnings before income tax EBT (Pre-Tax Income)
You can see your profitability before paying taxes in this line. You can understand how much the taxes you pay affect your profitability. It is the final subtotal line before you calculate the net income.
8- Income tax expense (Income Taxes)
In this section, it should be calculated how much tax you paid to the state. You will see the tax burden of your company. It is calculated over the period profit of the income statement. Tax rates may vary depending on the structure of the business, industry, or state. The total tax expense includes current taxes its also possible to cover the future taxes.
9- Net profit
The point you will reach after deducting your expenses is your net earnings.Net profit for the period is also part of the balance sheet. The analysis of the income statement is basically the subject of management accounting.
Is It Necessary to Use Software to Prepare an Income Statement?
Nowadays, firms that have reached a certain size use accounting programs, but small businesses, individual firms, can create their tables. You can create your income statement using excel and save all your income and expenses. if you know the items that need to be written in an income statement, all you have to do is enter the numbers correctly, which is the part of the job that needs to be done meticulously.
Single-step income statement vs Multi-step income statement
The sample income statement we prepared in this article is the Multi-Step income statement. The main difference between the two income statement types is that in the multi-step income statement, sub-totals are made at different stages to reach net income. For example, in this table, we got subtotals like gross profit and general expenses. We have reached net income by making multiple calculations.
In the single-step income statement, revenues and expenses are collected separately and the difference between them becomes your final income.
- All Revenues and Gains (sales revenues, interest revenues, gains on sale assets, other revenues, etc.….)
- All Expenses and Losses (Cost of goods sold, advertising, depreciation, rent, salaries and wages, supplies, other expenses etc.….)
(A) – (B) = Net Profit
The common size income statement
The purpose of this table type is to find the ratio of each item of expenditure and income to the total sales revenue. Taking 100% of sales revenue, we determine the percentage value of other expenses and income items and write them to each line. Common size income statements include an additional column of data that summarizes each line item as a percentage of your total revenue.
For example, here’s the income statement for New Age Restaurant. If we examine the figures on the table, if we compare with the actual sales, the ratio of overheads is 10% and Operating Earnings is 20%. These types of tables allow you to see the percentage of your company’s income and expenses as a percentage of each other and to interpret the changes experienced.
Preparing Financial Models & forecast future performance
There is software that enables us to analyze the inputs of income statements, for example by using data from the past few years, by reporting the rates and percentages of change in each income and expense item.
But well, we can make future predictions, for example, by entering the data in our income tables in the last 3 years into an excel table, we can try to integrate a proper financial model to forecast future performance.
In financial modeling, we will also need the balance sheet and cash flow statements that we have just mentioned, that is, we will need to tabulate historical data in all 3 tables.
Forecasting & Projecting Income Statement
Our main goal is to create a model by using the data, projecting income statement line items. not just the forecast. We need several income statements when preparing the habit of projecting the income statement line.
Basic Line Items to Forecast: By using the below lines you can arrive at net income, or the bottom lines of the income statement.
- Sales Revenue
- Cost of Goods Sold (or Gross Revenue)
- Total or Specific General Expenses (SG&A)
- Depreciation Expense
- Interest Expense
- Tax expense
What is the Income Statement Formula?
We have said that the simplest formula for achieving net income is to subtract expenses from revenues.
- Net Income = Revenues – Expenses
It consists of simple formulas that are referred to as an income statement formula, which shows how to calculate items such as gross profit, operating income, which we have explained throughout the article.
Income Statement Formulas are as below:
- Gross Profit = Sale Revenue – COGS (Cost of Goods Sold)
- Operating Income = Gross Profit – Operating Expenses
- Net income = Operating Income + Non-operating Items
Based on these formulas, we can create a complex formula for multi-step income statements:
Net income = (Revenues + Non-operating items) – (Cost of goods sold + Operating expenses)
It is important to read the income tables, analyze the situation of the company by formulating the figures in the tables, as well as the owners of the company or the employees of the financial department.
Being able to read, reflect on, reflect the data of a company over the past few years, determine the income level of the company and analyze +/- changes in revenues will give us an advantage in our commercial decisions and investments.