Preparing an Income Statement for a Business

5 of 10 in Series: The Essentials of Business Financial Statements

Before you can prepare an income statement for your business, you have to calculate Net Sales and Cost of Goods Sold using information that appears on your worksheet. Then, you can use the rest of the numbers from your worksheet to prepare your business’s income statement.

Finding Net Sales

Net Sales is a total of all your sales minus any discounts. In order to calculate Net Sales, you look at the line items regarding sales, discounts, and any sales fees on your worksheet.

For example, suppose that your worksheet lists Total Sales at $20,000 and $1,000 in discounts given to customers. Also, according to your worksheet, your business paid $125 in Credit Card Fees on sales. To find your Net Sales, you subtract the discounts and credit card fees from your Total Sales amount, leaving you with $18,875.

Finding Cost of Goods Sold

Cost of Goods Sold is the total amount your company spent to buy or make the goods or services that you sold. To calculate this amount for a company that buys its finished products from another company in order to sell them to customers, you start with the value of the company’s opening inventory, add all purchases of new inventory, and then subtract any ending inventory (that’s inventory that’s still on the store shelves or in the warehouse; it appears on the balance sheet).

The following is a basic Cost of Goods Sold calculation:

Opening Inventory + Purchases = Goods Available for Sale
$100 + $1,000 = $1,100
Goods Available for Sale – Ending Inventory = Cost of Goods Sold
$1,100 – $200 = $900

To simplify the above example for calculating Cost of Goods Sold, assume that the Opening Inventory (the inventory value at the beginning of the accounting period) and Ending Inventory (the inventory value at the end of the accounting period) values are the same.

Drawing remaining amounts from your worksheet

After you calculate Net Sales and Cost of Goods Sold, you can use the rest of the numbers from your worksheet to prepare your business’s income statement.

It’s standard practice to show three accounting periods on an income statement, so the following example lists three months’ worth of figures (but only shows actual numbers for one month).

Income Statement
Company X
May 2011
Months Ended

May

April

March

Revenues:
Net Sales $18,875
Cost of Goods Sold (6,500)
Gross Profit $12,375
Operating Expenses:
Advertising $1,500
Bank Service Charges 120
Insurance Expenses 100
Interest Expense 125
Legal & Accounting Fees 300
Office Expenses 250
Payroll Taxes Expenses 350
Postage Expenses 75
Rent Expenses 800
Salaries 3,500
Supplies 300
Telephone Expenses 200
Utilities 255
Total Operating Expenses $7,875
Net Income $4,500

Most business owners prefer not to show all their operating detail to outsiders. Remember, the more information you give to outsiders, the more they know about how your company operates, and the easier it is for them to come up with strategies to compete with your business. You should consider summarizing the Expense section in income statements that are distributed externally.

For external statements, many businesses group all advertising and promotions expenses into one line item and all administrative expenses into another line item.

Gauging your Cost of Goods Sold

Businesses that make their own products rather than buy them for future sale must track inventory at three different levels:

  • Raw materials: This line item includes purchases of all items used to make your company’s products. For example, a fudge shop buys all the ingredients to make the fudge it sells, so the value of any inventory on hand that hasn’t been used to make fudge yet should appear in the raw materials line item.

  • Work-in-process inventory: This line item shows the value of any products that are being made but aren’t yet ready for sale. It’s unlikely that a fudge shop would have anything in this line item considering fudge doesn’t take more than a few hours to make.

    Many manufacturing companies take weeks or months to produce products and therefore usually have some portion of the inventory value in this line item.

  • Finished-goods inventory: This line item lists the value of inventory that’s ready for sale. For a company that doesn’t make its own products, finished-goods inventory is the same as the inventory line item.

If you keep the books for a company that manufactures its own products, you can use a computerized accounting system to track the various inventory accounts. However, basic accounting system software won’t cut it — you need a more advanced package in order to track multiple inventory types.

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