We refer to an income statement as a financial statement that provides insight into a company’s financial performance. The Income statement is mostly referred to as a profit and loss statement but is different from a profit and loss report. It lists the revenues and expenses made by a company during a certain period.
An accountant can get an insight into the efficiency of the management in a company and an overview of various under-performing segments of the company. Let us understand how to prepare an income statement by identifying and recording the revenues and expenses. To create an income statement, you must first generate a trial balance report.
It also requires calculating the cost of sold goods, gross margin, net income, operating expenses, and income taxes, among other variables. Let us dive into the details and get to know how to prepare an income statement.
- How to Prepare an Income Statement?
- How does a balance sheet differ from an income statement?
- How can a company benefit when they prepare an income statement?
How to Prepare an Income Statement?
1. Choose a reporting period.
Income statements can be created for a certain period. Different businesses choose different reporting periods, mostly based on the scale of their businesses. Most businesses choose to report their income quarterly or yearly, as handling and analyzing a huge amount of data can be strenuous for most companies.
However, small businesses can choose to to prepare an income statement every month. Creating an income statement every month can help the business owner understand their revenues and expenses trends.
This, in turn, allows the company to create better strategies and generate more revenue in the end.
2. Generate the trial balance report
To prepare an income statement, one must first calculate the trial balance and generate a trial balance report. The trial balance report provides insight into the balance available in every account, which plays a major role in preparing an income statement.
An accountant would need the balance available in different accounts to create, which emphasizes the importance of a trial balance report.
3. Calculation of revenues
The very next step that needs to be taken to prepare an income statement involves the calculation of revenues across all streams. One must keep in mind while calculating the revenues that are yet to be collected are to be added as well.
You can add up all the revenue line items present in the income statement to do so.
4. Calculate the cost of sold goods
To prepare an income statement, one must also calculate the cost of goods sold. The cost of goods sold includes expenses such as direct labor and the cost of materials.
One must find the sum of the balances available in all cost of goods sold items available on the trial balance report and mention the total cost of all goods sold right below the total revenues generated.
5. Determination of the Gross margin
The gross margin is then determined by subtracting the total cost of goods sold from the earned revenues. This highlights the earnings you have acquired from sales during a certain period.
6. Consider operating costs
One must consider the operating costs to prepare an income statement. If an accountant fails to consider operating costs accurately, the income statement might also come out inaccurate.
Once the operating costs are calculated, they will be recorded in the selling and administrative expenses line. This is something ProfitBooks specializes in. Access lightning-fast up-gradation of different accounts, be it in the category of revenues generated or expenses made!
7. Calculation of the income
One can subtract the selling and administrative expenses from the gross margin to calculate their income. However, one is to keep in mind that the income obtained by a company is subject to taxing, which will further affect the net income generated by a company. This pre-tax income must be recorded at the bottom to prepare an income statement.
8. Calculation of income tax
Every business is subject to several tax rules and regulations that they are to follow, failing which they can face legal repercussions. Different states have different tax regulations. The calculated income tax is added to the income statement below the pre-tax sales figure.
9. Calculation of net income
The income tax calculated in the previous step affects the income made by a company. Therefore, it is to be considered while finding out the income generated by a company.
The calculated income tax is subtracted from the income figure calculated pre-taxing to prepare an income statement. This will allow you to understand how profitable your business is.
10. Finalization of the Income statement
Once you are done following the steps mentioned above, it is required that you finalize the income statement. You must add a header to the report, which labels it as an income statement.
Moreover, you will be required to include your business details and the accounting period chosen to generate the income statement. Once followed successfully, these steps will lead to the generation of an income statement.
How does a balance sheet differ from an income statement?
The balance sheet and income statement provide information regarding the available balance in different accounts. However, several distinguishing factors make it apparent that a balance sheet differs from an income statement, some of which are explained as follows:
When one tries to prepare an income statement, the information provided reflects the economical standings of a company during a certain period. However, in the case of a balance sheet, the information provided gives insight into a company’s financial health at a certain point in time.
In the case of an income statement, the information portrayed consists of revenues generated and expenses. In the end, we prepare an income statement to provide information regarding the profits or losses generated by a company.
However, in the case of a balance sheet, information regarding assets, liabilities, and equities is obtained. Thus, a balance sheet differs majorly from an income statement.
An income statement aims to provide insight into how a business is performing and understand whether it is being profitable. However, in the case of a balance sheet, the aim is to understand whether a company owns enough liquid assets to pay for all the financial obligations it is subjected to.
How can a company benefit when they prepare an income statement?
A business often finds it hard to understand whether its business processes are generating enough profits to facilitate organizational growth and expansion or not. The creation of an income statement takes care of this issue.
It allows an accountant to observe the balance available in different accounts labeled as expenses and revenues, therefore showcasing the profitability of the business. Third-party investors can also be lured in with the help of income statements. More profitable businesses seem to attract more investors as well.
Thus, every small or large-scale business must have income statements generated periodically to avail of these benefits.
It can get increasingly difficult to prepare an income statement for companies as they grow. Accurate record-keeping of different accounts gets even more hectic. This is what ProfitBooks can help you with.
With the help of accounting software like ProfitBooks, you will be able to automate the record-keeping process, which minimizes the scope of error and allows accountants to generate income statements in a small period! This, in turn, will allow accountants to focus on other tasks at hand, such as stratification for the growth of the business.
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