Financial Statement Preparation: The Income Statement

When you’re running a business, your income statement should be the financial statement you’re most familiar with. You use an income statement to track revenues and expenses so that you can determine the operating performance of your business over a period of time. Small business owners use these statements to find out which areas of their business are over or under budget. An outsourced financial controller in Phoenix can help ensure your Income Statement is accurate and up-to-date to ensure business decision-makers are making the best decisions possible.

What is an Income Statement?

An income statement is one of the three important financial statements used for reporting a company’s financial performance over a specific accounting period, with the other two key statements being the balance sheet and the statement of cash flows. Also known as the profit and loss statement or the statement of revenue and expense, the income statement primarily focuses on the company’s revenues and expenses during a particular period.

Why is the Income Statement Important?

As we mentioned above, you use an income statement to track revenues and expenses so that you can determine the operating performance of your business over a period of time. Small business owners use these statements to find out which areas of their small business are over or under budget.

These statements allow you to pinpoint specific items that are causing unexpected expenditures, such as cell phone use, advertising, or supply expenses. Income statements can also track dramatic increases in product returns or cost of goods sold as a percentage of sales and can be used to determine income tax liability.

An Income statement is one of the most basic elements required by potential lenders, such as banks, investors, and vendors. Your income statement may determine your credit limit or decide if you get a small business loan.

How To Prepare an Income Statement

As to the question of how to prepare an income statement, you’ll need to start this process by thinking in terms of who’s going to be looking at the income statement you’re preparing. If you are mostly using it for internal purposes, to make decisions about the company, then the precision of your income statement matters less.

Start by understanding each individual component:

  • Net Sales- These terms refer to the value of a company’s sales of goods and services to its customers. Even though a company’s bottom line (its net income) gets most of the attention from investors, the top line is where the revenue or income process begins.
  • Cost of Goods Sold- For a manufacturer, the cost of sales is the expense incurred for labor, raw materials, and manufacturing overhead used in the production of goods. While it may be stated separately, depreciation expense belongs in the cost of sales. For wholesalers and retailers, the cost of sales is essentially the purchase cost of merchandise used for resale. For service-related businesses, cost of sales represents the cost of services rendered or cost of revenues
  • Gross Profit- Gross profit is calculated by subtracting the cost of goods sold from net sales. It does not include any operating expenses or income taxes.
  • Operating Expenses- These are the daily expenses incurred in the operation of your business. In this sample, they are divided into two categories: selling and marketing and general/administrative expenses.
  • Interest Expense: This item reflects the costs of a company’s borrowings. Sometimes companies record a net figure here for interest expense and interest income from invested funds.
  • Total Expenses- This is a tabulation of all expenses incurred in running your business, exclusive of taxes or interest expense on interest income if any.
  • Pretax Income- Another carefully watched indicator of profitability, earnings garnered before the income tax expense is an important bullet in the income statement. Numerous and diverse techniques are available to companies to avoid and/or minimize taxes that affect their reported income. Because these actions are not part of a company’s business operations, analysts may choose to use pretax income as a more accurate measure of corporate profitability.
  • Net Income- (a.k.a. net profit or net earnings): This is the bottom line, which is the most commonly used indicator of a company’s profitability. Of course, if expenses exceed income, this account caption will read as a net loss. After the payment of preferred dividends, if any, net income becomes part of a company’s equity position as retained earnings.

Working with An Outsourced Financial Controller

To help you understand how your income statement should look, we suggest working with an outsourced financial controller who can look at your specific needs. Small business owners want something that gives them a clear picture of a company’s financial performance, and an overall picture of the company, over a range of time and at any moment in time.

Final Thoughts

The profit and loss statement uses data from your business and three simple calculations to tell you the net profit (or net loss) of your company. An income statement is a valuable tool to monitor operations in your small business and asses if you are making money. A P&L statement is also used to asses taxes on profits earned and is required by the IRS. This essential financial statement is best prepared by a professional- such as an outsourcer financial controller in Phoenix.

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