In the following article you will know what it is and how to make a Statement of income. In addition, you will learn to understand it and use it as a financial tool for your business.
The income statement is part of the 3 most important financial statements, together with the balance sheet and the statement of cash flows. It is widely used by accountants and business owners. and is also known as the profit and loss statement.
What is the income statement?
If the balance sheet presents the economic situation of a company on a certain date, the income statement, as its name implies, presents the results (profits and losses) of a company in a certain period.
That is to say, the income statement shows the amount of revenue generated and expenses incurred by an organization, during said period. To determine this information, the report gathers the company’s income, which is represented by sales, less cost of sales; for example the purchase of raw material. The result of this operation is the gross profit.
Likewise, it takes into account the administrative expenses and financial expenses to determine the operating profit and finally the net profit of the company. That is, what does the company have at the end of paying all its immediate obligations to continue operating.
If you’re not quite understanding, don’t worry. Keep reading that later we will explain what elements make up the income statement, how to do it and an example.
What are the objectives of an income statement?
The main purpose of an income statement is to measure the operating performance of the company, showing the reader how much profit or loss an organization generated during a given period.
This information is even more relevant when several income statements for consecutive periods are presented. This provides an opportunity to look at trends in the different lines of income and expenses from year to year.
Additionally, analyzing this information together with the other financial statements provides a very broad view of what is happening in the company and what areas should be taken into account. Other objectives of the income statement are:
- Identify in which part of the process more resources are being used.
- Provide an indicator to establish price points that customers will accept and that the company can provide.
- Evaluate the profitability of a business. That is, its ability to generate profits.
- Allow the investor to realize if the company generates constant profits to justify their investment.
- Give a bank or lender the data to know if a company can pay the installments and interest on a loan.
What items make up the income statement?
As we mentioned before, the income statement is, in a few words, a tool to know how much money a business has produced during a certain period. But to determine this information, it is necessary to analyze the following items.
Sales.
It will always be the first piece of information in an income statement. And as its name says, it is the money or income that has been generated by sales in a period of time.
Production cost.
This item is the money it cost the company to create and make available to its customers the product or service it sells. An example is labor and raw material. Keep in mind that this item involves the money that is directly related to the product.
Costs.
It is all the money that the company must pay that are not directly related to the product. We have 3 types of expenses:
- Administrative expenses: Administrative expenses are the money that the company uses for its operation, but are not directly related to the manufacture of the product or sales. These can be salaries, services, rent, etc.
- Selling expenses: It is the money that the company uses to generate sales. For example marketing and advertising, commissions to sellers, exhibitions, etc.
- Financial expenses: They are all the obligations that the company has with financial institutions. These can be the installments of a loan and interest.
Taxes
This item covers the expenses that the company must pay to the government of its country as a tax on the profit generated in a certain period.
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What results should I get?
Well, you may be wondering: And how do I use these items to make an income statement? The idea is that from the total sales, you will discount all the expenses that the company has and in the end you will know how much money you are left with. During the process you will get three results:
- Gross profit or sales profit = Sales – Cost of sales
- Profit before taxes = Gross profit – Expenses (Administrative, Sales, Financial)
- Net profit = Profit before taxes – taxes.
How to make an income statement?
Given the above explanations, you probably already have an idea of how to make an income statement. However, we want you to see this step by step, plus an example so that there are no doubts.
Obviously, large companies present much more complex and elaborate financial reports. But for the purposes of this exercise we will give a general explanation of how it is done.
- Determine the total sales of the company
- From the company’s total sales, you subtract the sales cost To obtain the Gross profit or sales profit.
- Once you obtain the gross profit, you subtract the costs To obtain the utility before taxes. Remember that expenses are made up of administrative, sales and financial expenses.
- When you have the profit before taxes, subtract the taxes To obtain the net profit.
Example of income statement.
As in the balance sheet article, we will use a fictitious company called “Ana María Ropa Deportiva”, so you can see the process. In this case the company had sales of $150,000; a gross profit of $58,000; earnings before taxes of $30,000; and net income of $18,000.
Conclution.
As you can see, the last column, called percentage, gives us the possibility to see in which items more money is allocated. As we mentioned earlier, this is a basic income statement example. It is presented in this way for the reader’s better understanding.
We hope this information is very useful for you and your company.
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