If you want to set up a business, an income statement is one of the most crucial things you will need. This is a financial document that shows your company’s profitability.
If you want to know how to prepare an income statement, there are a few tips and tricks to doing it effectively.
Here are a few tips and tricks to help you get started:
What Is an Income Statement?
It is a financial document summarizing a company’s income, expenses, net income, or profit (or loss) over a given period. To prepare one, enter the company’s total revenue from sales, services, and other income sources.
Other items, such as discontinued operations or extraordinary gains or losses, may be recorded. Make sure to consider timing differences as well. Finally, consider non-cash expenses when preparing the income statement.
After the income statement is complete, review it for accuracy and completeness and analyze it for trends. Use the data to manage the company’s performance better.
Select Your Reporting Period
It is vital to select a reporting period to analyze the financial performance of a business over a specific timeframe. Generally, the reporting period is set for 12 months and starts at the beginning of a new business year. A reporting period can also be set to one month or quarterly, depending on a company’s needs.
For an income statement, the reporting period is usually an entire accounting year, typically 12 months long. It is essential to select a reporting period that is relevant and consistent so that any future analysis can be compared accurately.
Once the reporting period is identified, you can prepare the income statement by gathering revenue and expense data within the specified timeframe.
Calculate the Total Revenue
Calculating the total revenue is the first step in preparing an income statement. This will include sales, interest income, and any other income the company may have received.
Once these amounts have been calculated, subtract the total costs from the total revenue to calculate the net income for the period. Once the financial figures have been recorded, the income statement can be prepared to illustrate the company’s income, expenses, and subsequent profit or loss.
Calculate the Cost of Goods Sold (COGS)
The cost of goods sold must be computed to prepare an income statement properly. This can be achieved by beginning with the inventory at the start of the period. Add any more purchases to the total, then deduct the cost.
This difference and the cost of labor, materials, and overhead must then be added to determine the total Cost of Goods Sold. Finally, deduct the total COGS from the total sales to calculate the company’s gross profit.
Knowing these amounts is essential for reporting on a company’s financial health. This should always be accurately recorded in an income statement.
Calculate Gross Profit
To properly prepare an income statement, one must first calculate gross profit. Gross profit is computed by deducting the cost of goods sold from total sales. Essentially, the cost of goods sold is the cost of producing goods or services.
It should include direct labor, materials, and other costs that can be directly traced back to producing goods or services. Once gross profit is calculated, the remaining income statement steps should follow accordingly.
This includes subtracting operating expenses, depreciation and amortization, taxes, and interest to reach a net profit figure. With the net profit figure, one can determine the entity’s profitability.
Calculate Operating Expenses
Operating expenses can be broken up into two categories – direct and indirect. Direct payments are tied to producing goods or services, such as materials, labor, and direct marketing costs. Indirect expenses such as rent, utilities, taxes, and administrative fees support production.
The company should identify its total revenue and subtract the cost of goods sold to calculate operating expenses. Then remove all the direct and indirect expenses discussed above.
This will give the company a net operating income, which can be used as a reference on the income statement. It is important to remember that operating expenses can change occasionally. It is necessary to ensure they are always accurate.
To do this, add up all of your income sources, such as wages, investments, and business income. Once you have the total revenue, deduct applicable federal and state taxes. The total after taxes should be your net income.
Then, subtract all relevant expenses such as rent, utilities, and loan payments. Finally, remove any non-operating income items such as interest and extraordinary things. The total of this should be your operating income.
The overall result should be your net income, which can be used to create the income statement. It should include an overview of the period’s revenue, expenses, profits, and losses.
Calculate Interest and Taxes
Take into account all income taxes that must be paid. Calculate the total owed, then determine the percentage of income to be paid in taxes. Next, calculate any outstanding interest fees on payments due.
Consider all potential deductions from interest and taxes that may be applicable, such as deductions related to investments. Any interest fees for payments made before the reporting period can also be included on the income statement. Finally, use these figures to determine the overall net income for the reporting period.
Calculate Net Income
Start by calculating the gross income generated from sales and other income sources minus applicable discounts. Next, subtract the cost of goods sold, which is the cost of the items sold during the period, to arrive at gross profit.
Subtract total expenses from the gross profit to determine the total income or operating profit. Finally, calculate the net income by subtracting taxes from the total revenue, equaling the net income for the period.
You may consider revenue recognition to guarantee that accounting records are accurate and up to date in real time.
Understanding the Steps on How to Prepare an Income Statement
Having completed the steps on how to prepare an income statement, you have gained the necessary knowledge to make informed business decisions. Use this information to guide your next business moves toward success. With an accurate and up-to-date income statement, you are ready to make confident financial decisions.