Starting a business is probably one of the most challenging tasks to do. Having background knowledge regarding business and marketing will ease the burden. However, if you are one of those whose courses are unrelated to business and marketing, it could be an uphill battle. You will need some assistance if you want to move ahead of your business.
Before anything else, you need to get yourself familiar with the things that will be useful in running your business. One of the most important things that you need to keep in mind is the income statement. You have probably heard of this while working in a department store or a retail store. This term is also called the Profit-and-Loss Statement.
Every business, whether it be a startup business or a longterm running corporation, needs to have an income statement. It’s almost impossible to run a business without the income statement.
An income statement is a direct report of how the business is running. It acts as a scorecard for your company’s financial performance. Your income statement will reflect the expenses incurred, the number of sales, and the net profit of your company. Business owners don’t survive without the income statement. But how important is it?
Income statements are significant. Public corporations are even required by the government to submit this statement. Aside from abiding by the law, income statements allow you to see the trend in your business. An income statement will be like a compass that will point to which direction the company should go.
What is in the Income Statement?
Revenue – This is the total amount of money that goes in through the business’ activities. Revenue is also known as sales, and this already includes the deductions for returned merchandise and discounts.
Expenditures – There are two types of expenditures: Capital expenditure and revenue expenditure. Capital expenditures are expenditures that yield benefits over multiple periods, just like money spent to acquire assets. Revenue expenditure, on the other hand, is the expenditure that has the benefits but only in a specific period. One example of revenue expenditure is the cost used to acquire products intended for sale.
Cost of Goods Sold – This term (also called COGS) refers to the direct money you spend on producing the products that are sold by your company. When you are a retailer, the cost of your goods is not only the price you pay for the goods from the supplier. You have to account for transportation and other charges in obtaining your product and making it available to your customers.
Gross Profit – This is the total money left from subtracting the money you spend from obtaining and selling your products, or from providing your services to the customers. This is the amount you get from subtracting the COGS from your total revenue.
Operating Expenses – These are expenses that a business incurs due to its normal business operations. Operating expense, also called OPEX, includes rent, inventory costs, equipment, payroll, marketing, insurance, step costs, and funds that are allocated for the research and development.
Depreciation – When you buy a car, a year later, it won’t have the same market price anymore. The same goes for our cellphones. The value of it is decreasing as time goes by. The moment we use it, it already loses some of its value. This doesn’t apply to the gadgets we use. Machinery, equipment, and other business goods also lose their value over time. You have to account for the depreciation value in your income statement, as well.
Earnings Before Interest and Taxes – This term refers to the company’s net income before deducting the interest expenses and tax expense from the revenue. This is an indicator of the company’s profitability.
Earnings before Taxes – This term refers to the money left when you subtract the expenses from revenue. The expense does not include the taxes that you still have to pay. It reflects the company’s earnings when you deduct the COGS, depreciation, interest, administrative and general expenses, and other operating expenses.
Earnings Available for Common Shareholders – We put this value in the income statement if your company has some investors, or if you are taking a salary from the company. This one is important because this shows the net after-tax profit, deducting any dividends for preferred shareholders
Extraordinary Expenses or Special Items – Some events can cause charges against the income. You can also identify them as restructuring charges, nonrecurring or unusual items, and discontinued operations. These circumstances are usually one-time events. However, they still need to be reflected in the income statement.
Owner’s Draw – This is the salary of the business owner that comes out of company revenues
Net Profit – This one is the bottom line of your income statement. The net profit is money left after you have deducted all the expenses that you had. If the business status is good, you’ll see a profit. That is, you have gained from your business. But sometimes, you’ll see a loss. It only means that you have spent more than you gained. This situation is quite common, especially for those who are just starting up their business.
Now that you know the usual items reflected in the income statement, it’s time that you determine how to make your income statement.
How to Make an Income Statement
There are easy ways to have your income statement. You can make use of accounting software available online. There are a few good accounting software available, but you need to have to choose reliable ones. To make sure the software is secure, you have to buy it to use it. If you don’t want to spend on minimal things unnecessarily, you can create your income statement on your own.
You can make your own income statement by following these steps:
You need to prepare the revenues of your business for each quarter of the year. This will be your foundational value in your income statement. You have to make sure that you have included all the money brought into your company.
You have to itemise the expenses of your business for each of those quarters. There were various expenses that we have discussed earlier. You have to note whether it is an operating expense, cost of goods sold, or other expenses mentioned previously. Remember that you have to input all the money that went out of the company.
Deduct your overall expenses from your gross profit to get your EBIT in each of the quarters, and for the whole year
After getting your EBIT, you then need to calculate for your interest and taxes. Computing for the interest and taxes is quite complicated, and it requires in-depth knowledge to be able to get things done. If you don’t have a background about getting the interest, you can get some professional to help get things done for you.
After subtracting the interest and taxes, it’s time for you to determine if you have a profit or a loss.
Analysing Your Income Statement
Before anything else, you have to be reminded that you should not become overwhelmed by looking at your income statement, although it may indeed appear overwhelming at first glance. It is intended to give you an overview of how your company is running financially.
The income statement will generally give you the income generated, the expenses, and the profit or loss. The ultimate output of your account is the profit. If you have expenses more than earnings, you’ll most probably see a loss at the end of your income statement. It will yield a negative value. In accountancy, they express negative values with a parenthesis.
When you have a profit, you have to take note of where most of your income came from. If you have both physical and online stores, you need to account for those as well. Determine whether it’s your physical store that yields the most profit, or your online store.
Then, it’s time for you to see the areas where you have spent a lot. You can start looking for the highest value in your expenses and see where most of your money goes. Knowing this will help you mitigate unnecessary spendings.
The challenge goes when you see a loss at the end of your income statement. It might be disheartening, but remember that most businesses undergo this predicament before surmounting obstacles. When you have the income statement, seeing a negative value at the end won’t take away all your hopes.
Look at your income statement again and see where you have spent more on. You need to analyze your expenditures and see whether the money was spent on worthy things. Aside from that, you should also look at your sources of income. You also have to know which part of your income-generating scheme needs to be improved. If your online store keeps on losing money, then it’s time to give it a halt. Or, you can advertise your online store more so it will also generate more income.
Based on the digits reflected on the income statement, you can determine the action that you need to do next in order to make your business profitable.
But income statements can both have a positive and negative impact on your company. Here are the lists of the advantages and disadvantages of having an income statement.
You need to look for investors in order to grow your business. Once you find investors, you need to show them that your business is capable of investing their investments. When you promote your business to banks for loans and to investors, they will take a look at your income statement to see whether you can hold the money well. If they know that you have what it takes to grow their money, they will willingly invest in your business.
Income statements track the company’s performance. As previously mentioned, income statements can show how your business is going financially. It can reflect the spendings and the earnings and, thus, determine whether there is a right balance in the finances.
It is used for forecasting. With the income statement, you can have a foundation in forecasting future accounting periods. This means you can prepare for future expenses.
Income statements can make tax reporting easier. Any business needs to abide by the laws of the state. That includes tax compliance. Having an income statement in hand will make things easier when you are paying for your taxes. The sector will have a plain view of your finances already.
It can determine the areas of improvement – As mentioned previously, with your Income Statement, you can see where you have been spending more money and the source of income that needs to improve. It will be easier for you to know your next move based on the financial movement of your business.
It can misrepresent the real value of the company. The income statement is considered by many as the measuring stick of the company when it comes to success. However, any business can go through a stage of hardship and can yield a loss at the end of the income statement. This will leave a negative impression on other investors, even if the company performs well generally.
It does not analyse non-revenue factors. As it only measures the financial aspect of the company, other successes such as the increase of brand awareness might not be given much importance.
It requires time to prepare. Making an income statement is not easy, and it could cause headaches. When your business starts to grow, you will need to spend more time making this statement.
Generally speaking, having an income statement is really beneficial. But you need to make use of the income statement in a way that will benefit your business. When you are conducting your business, there’s a lot of factors to consider. But you should always keep the income statement in mind. This will serve as your GPS in your business path.