The Income Statement—also called the Profit & Loss Statement—is used to weigh a company’s revenue against its expenses in order to calculate its profits. Comparing Income Statements over a period of time helps a company evaluate where they can reduce expenses, grow revenue and increase profit overall.
1. Pick a Time Period
An income statement can be calculated on a monthly, quarterly or annual basis to measure your company’s profits on a macro or micro level. There are various federal regulatory agencies that require companies to prepare their financial statements on both a quarterly and annual basis for tax purposes. On top of this, many companies choose to create income statements on a monthly basis to look for patterns in their profits and expenditures.
Any company that is considering applying for a business loan will need to use income statements to show sufficient stability and growth over a period of time.
2. Add Up Revenue
The first number to tally on an Income Statement is your total sales. For cash-based businesses, which document sales based on when a customer makes a payment, you will add up the total cash you have already acquired. If your company operates on the accrual method, this means you recognize transactions when the goods have been delivered but your business has not necessarily been paid. In this case you will also include accounts receivable (money owed) as revenue.
Depending on the service or product your company provides, the source of your income may differ. Total sales can be added up from the records in a cash register, receipts or invoices from client payments, or transactions that have processed through online payment systems.
3. Calculate Expenses
Expenses include all of the money spent by the business in order to produce revenue in a direct or indirect way. This includes:
- Cost of Goods (physical product): raw materials, production, equipment, packaging, etc.
- Cost of Services (service or online product): web hosting fees, cost of service delivery, data storage, site maintenance, etc.
- General & Administrative Expenses (G&A): day-to-day office management costs like rent, utilities, depreciation, telephone bills, etc.
- Employee Compensation: salaries, payroll services, benefits, etc.
- Marketing & Advertising: online marketing, email marketing services,mobile marketing, company website (for physical businesses), billboards, PR firm expenses, etc.
While you can add these items together as groups—for example, lump together the total G&A expense every month—it’s also a good idea to keep individual items on separate lines so you can compare specific expenses and consider where they can be reduced. For example, if most of the G&A expenses remain static but the utilities start going up dramatically, you can start encouraging more employees to turn off lights and computers when they leave.
4. Determine Profit
There are several different types of profit that you can evaluate, and each can be useful to compare on a monthly and quarterly basis. If you subtract the Cost of Goods from the Sales, you will be left with the Gross Profit. Subtract the remaining costs (General and Administrative expenses, salaries, marketing, etc.) from that number to get the Operating Profit. To determine the Net Income, in other words, the actual income the business takes home, subtract the tax amount for that period.
Secondary Expenses and Revenues
Some businesses incur gains and losses from activities outside of their primary one (buying and selling goods or services), for example from lawsuit wins or losses, interest earned on business savings accounts or the loss or sale of long-term assets. If any of these variable expenses affect your company’s income or expenses, be sure to include them in the statement as well.
Overall Financial Evaluation
When done consistently, the Profit and Loss Statement can also be used for financial projection, to estimate the viability of new projects, set goals for the future and secure funding.
The Income Statement is a key component of a company’s financial statements, which should be prepared on at least a quarterly basis to evaluate the financial health, value and growth of a company. The Income Statement, Balance Sheet and Cash Flow Statement are generally considered the most important documents for evaluating the financial state of a company, and each should be completed on at least a quarterly basis.
Article by Rochelle Bailis