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How to write an income statement to meet the correct standards

A simple explanation to show you how to write an income statement which is the most important financial document in business

Why is it important to know how to write an income statement?

An income statement is one of the most important financial documents and it presents the company’s revenues and expenses during a predetermined period of time. It is a good predictor of a company’s financial status and it can help the company management or investors and creditors to better understand how financially successful the company is. To put it simply, this document is important to tell a potential investor how much money is left in the company after all the expenses have been paid, and that figure is called net income, or colloquially the “bottom line." You need to know how to write an income statement no matter the size and the activity of your business.

Net income is used to calculate earnings per share, and that is an important predictor of profitability for investors who buy shares of that company on the stock market. They want to know how much profit each of the shares they own will bring them. That’s among the reasons why it is important to know how to write an income statement correctly.

The income statement has some limitations about predicting the company’s financial success. Large one-time gains could overstate the bottom line. Also, it doesn’t say anything about the future prospects of a company; the strength of company’s brands or loyalty of its customers; it is simply a historical account of the company’s finances for a chosen period of time. It could also be distorted by changing accounting method.

Most important concepts

You need to understand these basics in order to know how to write an income statement:

  • Net income is most simply defined as the difference between the company’s revenues and its expenses.
  • Revenues represent the money that comes into the company from the customers or consumers from selling that company’s product or service. Some companies use it interchangeably with the term sales while others define sales as the number of a product (services) that they’ve sold in a set period of time. For example, a toy company sold 35000 of their most popular toy cars (sales) which brought them a revenue of $350000. They will positively affect the net income.
  • Expenses are the money that company needs to spend in order to produce revenues. They are, for example, costs to purchase raw materials for production, equipment to make a product, salaries for the employees, expenses of running a facility - such as electricity or rent, money spent advertising the product, transporting it to the buyer, etc. They will decrease the net income.

A simple guide for making you understand how to write an income statement

We will show you a detailed explanation on how to write an income statement using multi-step approach. This is an approach that connects selected types of information that are presented in the report as subtotals, which makes it easier for readers to draw conclusions about the company and the success of its business in that chosen period of time. Most important subsections are the gross profit, which shows how much the company earns just from its primary activity of selling merchandise, what it spends on operations and activities that make creation of that merchandise possible (operating expense) and gives a separate overview of the company’s results that are not related to its primary activity of selling a product (the other income total).

First, you will need to define a time period for your income statement. Income statements are created to measure revenues and expenses during the previously stated period of time and they are most often made in monthly, quarterly, or annual basis. For publicly traded businesses it’s required by law to generate quarterly and annual basis income statement reports to file with the Securities and Exchange Commission. All companies can also generate income statements periodically to help them identify business trends and to make internal evaluations of their financial results.

Here we give you an overview to show you how to write an income statement that must have certain sections correctly formatted:

  • Header that contains the name of the company on the first line. Directly beneath that, you must write the title Income Statement and below that you state for which time period is that income statement created.
  • Body of your income statement needs to have four separate subsections. The first subsection calculates gross profit as a difference of revenue generated by sales and the costs of goods that are sold. The second subsection calculates operating income as a difference of gross profit and operating expenses. The non-operating income is covered in the third subsection, and it’s a difference between non-operating revenues and expenses. The fourth and final subsection uses all the previous information to calculate the value of net income.

The Gross Profit subsection

This section is immediately under the income statement header and the first thing you’ll need is to list all sales revenue for that chosen period of time (under the subtitle Sales revenue, of course). All revenues earned during your chosen period of time are added here, even if the cash for them has not been yet collected, for example if your customers will pay monthly for a large amount of products ordered once. Below that is a subtitle Cost of goods sold that lists all the cost needed to sell items previously stated as revenue. Most commonly this refers to wages for the direct labor of workers that made your product, direct materials needed in manufacturing it, facility running expenses etc. For the reseller, this is typically the price that was previously paid to purchase inventory.

Finally, after subtracting cost of goods from sales revenue you get a result that should be written under the next subtitle Gross profit. It represents the money that a company earns from selling their products before general, administrative and selling expenses are paid.

The Operating Income Subsection

First you need to list all operating expenses of your business, and those are expenses that directly come from business administration, such as salaries for all employees who are not directly involved with manufacturing of the goods, and you have to know what they are in order to know how to write an income statement properly. Some examples include office supplies, utilities, rent, fees for professional consultants or analysts, expenses for transportation of the goods, property taxes, and costs for marketing the product. Just make sure to thoroughly think about these expenses for your unique case.

There are also non-cash operational expenses that must be included. We need to explain terms amortization and depreciation in order to cover all the crucial information on how to write an income statement. Depreciation is a practice of allocating the cost for that purchase over a certain period of time. Amortization is a similar concept that deals with intangible assets. An example for amortization would be prolonged brand recognition because of paid advertisements that will last for a longer time. These techniques help with not bringing the company’s net income down sharply after an important investment.

Next step is creating a sum of each of the previously listed operative expenses to create total operating expenses. These need to be subtracted from gross profit. You’ve just calculated your operating income. This is the income earned from normal and necessary core business functions and sometimes it’s called earnings before interest and taxes.

The Non-operating Income subsection

This income refers to income made by short-term investments such as savings, sales or exchange of currencies because that money will earn interest. This is an additional source of income for a company and it needs to be written down with appropriate revenue values.

Non-operating expenses include interest expense paid to lenders or bondholders, losses from the sale of the company’s investments, and money lost by selling investments.

When you subtract the revenues from expenses you will get your non-operating income for that time period.

The Net Income subsection

This is the final part of your income statement and it’s simply the sum of operating and nonoperating income. These retained earnings can now be used to pay dividends to owners or for reinvestment in business activities. You are finished!

We have shown you how to write an income statement using multiple step method because it has many advantages over single step method:

  • It clearly states the gross profit amount. This is often used by analysts to determine a company's gross margin (that is, they calculate gross profit divided by net income in a form of percentage). Readers may compare a company's gross margin with its previous gross margins and with the gross margins of similar businesses in the industry.
  • Important financial information that is calculated is the operating income, which shows the profit earned from the company's primary activities.
  • Net amount is an important indicator of how profitable the company is. If the net amount is positive, it is called a net income. Net loss is a term for negative net amount.

A simple explanation to show you how to write an income statement which is the most important financial document in business

Why is it important to know how to write an income statement?

An income statement is one of the most important financial documents and it presents the company’s revenues and expenses during a predetermined period of time.

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Assignment ID
100000013
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CREATED ON
June 17, 2016
COMPLETED ON
June 18, 2016
Price
$34
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