Income Statement Basics

Definition of Income Statement Basics

The following article provides an outline for income statement basics. Income statement is the summary of income and expenses which reflects the profitability of the company over the financial period under consideration by showing the gross profit and net profit earned during the year where the basic components of the income statement include sales, cost of goods sold, operating expenses etc. on the basis of which the gross profit and net profit is determined.

Explanation

The income statement is the statement which shows the income earned during the year. Net Income is determined by sales less all expenses. The income statement starts with the revenue, which includes sales made to customers during the year. Other revenue includes the direct income like sale of scrap, sale of byproducts etc. Non-operating income includes interest income, dividend income etc. To arrive at the net income cost of goods sold and other operating and non-operating expenses are to be deducted from the revenue.

Cost of goods sold includes the manufacturing expenses and other direct expenses, whereas operating expenses includes Administration expenses and selling and distribution expenses, depreciation, amortization etc. income statement is the basic statement forms part of financial statements. The basics of an income statement are revenue and the cost of goods sold. Cost of goods sold is calculated as opening stock plus purchases plus direct expenses less closing stock. The income statement is the summary statement of income and expenses.

How to Create a Basic Income Statement?

The step-wise creation of the income statement is determined as under:

• Step 1: Select the period for which the income statement is to be reflected.
• Step 2: Generate the Trial Balance Report for the period, which is used to prepare the income statement.
• Step 3: Determine the revenue for the period. Revenue is the sales made to the customers by raising the invoice, whether on cash or on credit.
• Step 4: Determine the Cost of goods sold for the period. Cost of goods sold is opening stock at the beginning of the period add purchases made during the period whether on cash or on credit add direct expenses like carriage inward, direct wages etc. less the closing stock at the end of the period.
• Step 5: Determine the Gross Profit from the following formula:

Gross Profit = Sales/ Revenue – Cost of The Goods Sold.

• Step 6: Determine the company’s operating expenses, which is the expenses incurred by the company business during its normal business course. It is located below the gross margin line of a company.
• Step 7: Determine non-operating expense and the company’s non-operating income, which are the expenses/income of the company from the sources other than normal business operation.
• Step 6: Determine the Net Profit from the following formula:

Net Profit = Gross Profit -Operating Expenses – Non-Operating Expenses + Operating Income

Basic Example of Income Statement

The Revenue of the ABC Ltd. is $ 900,000 for the year 2019-20. The organization is a newly started company; hence there is no opening stock. Purchases made during the year were $ 600,000, Manufacturing expenses were $ 23,000, direct labor costs were $ 70000. The organisation’s Administration was $ 70000, selling and distribution expenses were $ 45000, advertising expenses were $ 15000, and repairs to the building amounting to $ 15000. Stock in hand at the end of the year was $ 100,000. Prepare the Income statement of the organization. Calculate the gross and net profit and determine the basic elements from the above that directly contribute to the organisation’s operations.

Solution:

Income Statement of ABC Ltd. for the year ended 31st March 2020.

Particulars	Amount ($)
Revenue	900,000.00
Less: Cost of Goods Sold	593,000.00
Gross Profit	307,000.00
Less: Operating Expenses
Administration Expenses	70,000.00
Selling and Distribution Expenses	45,000.00
Advertising Expenses	15,000.00
Repairs and Maintenance Expense	15,000.00
Net Profit	162,000.00

Cost of Goods Sold is calculated as

Calculation of Cost of Goods Sold	Amount ($)
Opening Stock	–
Purchases	600,000.00
Direct Expenses
Manufacturing Expenses	23,000.00
Direct Labour	70,000.00
Less: Closing Stock	(100,000.00)
Cost of Goods Sold	593,000.00

Basic Elements that contribute to the organisation’s operations and profitability are revenue and cost of goods sold. The higher the revenue of the company, the higher will be the chances of earning the profit, but if the cost of the goods sold is higher than the revenue, then there are chances of loss also. Hence these two elements play a vital role in the profit and other operations of the organization.

Components of Income Statement Basics

Basic Components of Income Statement includes the following:

• Revenue: Revenue is the sales or gross receipts of the organization that arrived from the sale of goods or providing of services. The Accuracy of Revenue can be verified from verification of the bills raised. The bills raised for the period should be tally with the revenue of the organization.
• Cost of Goods Sold: Cost of Goods Sold is arrived from opening stock add purchases and direct expenses less closing stock. Opening stock is the stock in hand at the beginning of the period; it can be verified with the closing balance of the last year. Purchases include the purchases made during the year, and they can be verified from the corresponding bills. Direct expenses include the expenses related to purchasing like manufacturing expenses, direct labour etc. it also can be verified from the payment vouchers. Closing stock is the stock in hand at the end of the period, and it can be verified from the stock register maintained by the organization.
• Gross Profit/ Loss: Gross Profit is calculated as revenue less cost of goods sold. There are also chances of gross loss if the cost of goods sold is the higher than the revenue. It happens where the sale price of the product declined due to various reasons.
• Operating Expenses: Operating expenses refer to the expenses incurred out of the normal business operations. It includes the Administration expenses, which includes the salaries and wages to the office staff for their services, selling and distribution expenses, and forms part of the indirect expenses, including packing expenses, delivery expenses, advertising expenses, etc. General Expenses includes all miscellaneous and petty expenses which do not fit under any head of expenses.
• Non- Operating Expenses: Non-operating refers to the expenses incurred from activities that are not related to normal business operations. They are to be shown separately from the Operating expenses as they are considered non-operating expenses, which play a vital role in determining the organisation’s profit. Examples include loss from investment, write off of intangible assets etc. Gross profit less cash and non-cash operating expense is net profit.

Conclusion

An income statement is a statement that shows the organisation’s result, i.e. whether it has made a profit or loss during the period. The basic elements of the income statement consist of sales, cost of goods sold, direct expenses and indirect expenses. The important elements which contribute to the profit are revenue and cost of goods sold. It is proforma for income statement through which it can be presented better.

Recommended Articles

This is a guide to Income Statement Basics. Here we also discuss the definition and how to create a basic income statement? Along with components of the income statement. You may also have a look at the following articles to learn more –

1. Accounts Receivable Factoring
2. Accounting Equation
3. Accounting for Derivatives
4. Mark to Market Accounting