Your income statement should be the financial statement you are most familiar with when you are running a company. Your income statement is an up-to-date, on-demand tool in a perfect world to know how much your company has done in a given period of time.
Plus, a statement of income (also known as your statement of profit and loss) will be a crucial piece of paperwork for various small business finance processes, such as applying for small business funding.
And a statement on sales is surprisingly easy to understand for something so important to the finances of your business. Especially if you are as familiar with small business finances as most business owners are, wrapping your head around the basic concept behind an income statement is quite easy:
All Gain – All Expenses = Net Income
You get to this point-over and above the basic concept behind a declaration of income, things can get a little bit more complicated than the difference between your total income and your total expenditures.
Knowing the dynamics beyond the income statement of each company
At the beginning, most small businesses think the income statement is very simple, but it may be infinitely more complex than you would have thought in depending on your business model. We want to get this point across before we delve into all the details about how these complexities can arise.
Let’s say you’re running a retail company for example. The freight you pay is COGS (cost of goods sold) to get your product into the warehouse before it’s finished. The freight you pay to send your clients inventory is not COGS!
COGS is defined as all the costs involved in getting the products ready for sale. The products had been sold by the time you ship to your client, meaning they were already “made for sale” by the time they were delivered. That’s a sales price, not COGS, leaving the income statement ripe for confusion and mislabeling.
Do you want to see any fascinating explanations of how to get complex income statements? Google your favorite online retailer+ “Income Statement.” Check out Best Buy’s income statement, for example. This should keep you busy for a while and finally get the point across — the more your business grows and evolves, the more complicated your statement of income.
Preparing the most accurate statement of income
As to how to plan the income statement, you’ll need to continue this process by thinking about who’s going to look at the income statement you’re writing. If you use it mostly for internal purposes, to make decisions about the company, then the accuracy of your statement of revenue is less important.
Much of the time, the person who prepares the tax will be the only person in the business to look at the internal income statements. This will certainly provide you with some feedback about what you need to include in your report for a tax return. Apart from what your business tax needs prepared from your income statement, it will mostly be up to you.
If your business does not have an inventory
Technically, if you’re not selling inventory, then you’re not making COGS. Nonetheless, many service-based companies use their income statement’s COGS segment to define “internal costs,” costs that would only be incurred if sales were received from the services in question. Of example, a bookkeeping company can show the wages they pay as COGS to their bookkeepers, so they can see a gross profit number that shows how much money they make directly on their bookkeepers.
If you are in a loan
Loan covenants— which you must obey if you have a loan or credit line with your bank— could have an effect on how you manage your finances, but much of that is likely to have an impact on the balance sheet rather than your statement of income. That said, if you have a loan or credit line, there are certain metrics that you might be calling for special attention in your income statement. Any “return” ratios, such as “return on investment” or “return on assets,” means we bring net income into the numerator. The question becomes: Which items are to be included in “operating income” and what things are to be put “under the line?” You will have to pay close attention to this numerator problem.
The problem becomes:
What items are to be included in “operating income” and what things are to be put “under the line?” If your company has a loan, you will need to pay close attention to this issue of numerator and denominator when you construct the income statement.
If you are partnering with investors
Investors often want to see what’s called EBITDA, which is a type of statement of income indicating earnings before interest, taxation, depreciation, and amortization. And that’s just because investors want to look at how the company is doing without taking into account these strange data. It gives investors (and possibly lenders too) a clearer picture of how the business actually operates without having to include tons of distracting numbers. In such situations, you want to set up such reported accounts as “Other Income / Expenses” so that they appear at the very bottom of your statement of income, “below the graph,” where the line is the operating profit, or net ordinary income.
If you are employing the services of a professional
For help to understand how your income statement will look, we suggest working with an accounting officer who can look at your specific needs. In addition, accountants would typically start with the most minimal chart of accounts when setting up a chart of accounts for new companies. This helps them to build whatever they need as we go. Through this process, the chart of accounts and the financial reports and income statements take shape as they go forward and document financial transactions depending on what needs occur.
In the end, it is obvious what accountants want from an income statement— something that gives them a straightforward view of the financial results of a company, and an overall image of the company, over a period of time and at any point in time. From an audit perspective, accountants require something that accurately presents a company’s financial image in all material respects.
As you look at your own income statement as a small business owner, you will be able to get the impression that it “looks good.” And even though small business owners are not usually accountants, as business owners tell an accountant that an income statement doesn’t look right, an accountant may believe it. A competent accountant would then dig in and find out where and why it might be wrong.
An accountant will then fix something that needs to be corrected, or simply get proof that it’s actually right.