Updated July 14, 2023
Definition of Income Statement Basics
The 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.
The following article provides an outline for income statement basics.
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 direct income like the 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.
The cost of goods sold includes manufacturing expenses and other direct expenses. In contrast, operating expenses include Administration expenses and selling and distribution expenses, depreciation, amortization, etc. income statement is the basic statement that forms part of financial statements. The basics of an income statement are revenue and the cost of goods sold. The 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 will be reflected.
- Step 2: Generate the Trial Balance Report for the period used to prepare the income statement.
- Step 3: Determine the revenue for the period. The organization raises invoices, whether for cash or credit, to customers to generate revenue from sales.
- Step 4: Determine the Cost of goods sold for the period. The cost of goods sold is opening stock at the beginning of the period, adding purchases made during the period, whether on cash or credit, adding direct expenses like carriage inward, direct wages, etc., less the closing stock at the end.
- Step 5: Determine the Gross Profit from the following formula:
- Step 6: Determine the company’s operating expenses, which are 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 expenses and the company’s non-operating income, which are the expenses/income of the company from sources other than normal business operations.
- Step 6: Determine the Net Profit from the following formula:
Basic Example of Income Statement
The Revenue of ABC Ltd. is $ 900,000 for 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, and direct labor costs were $ 70000. The organization’s Administration was $ 70000, selling and distribution expenses were $ 45000, advertising expenses were $ 15000, and repairs to the building amounted 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 organization’s operations.
Solution:
Income Statement of ABC Ltd. for the year ended 31st March 2020.
| Particulars | Amount ($) |
| Revenue | 900,000.00 |
| Less: Cost of Goods Sold | 593,000.00 |
| Gross Profit | 307,000.00 |
| Less: Operating Expenses | |
| Administration Expenses | 70,000.00 |
| Selling and Distribution Expenses | 45,000.00 |
| Advertising Expenses | 15,000.00 |
| Repairs and Maintenance Expenses | 15,000.00 |
| Net Profit | 162,000.00 |
The cost of Goods Sold is calculated as
| Calculation of Cost of Goods Sold | Amount ($) |
| 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 |
The basic Elements that contribute to the organization’s operations and profitability are revenue and cost of goods sold. The higher the company’s revenue, the higher the chances of earning a profit, but if the cost of the goods sold is higher than the revenue, then there are also chances of loss. Hence these two elements play a vital role in the profit and other operations of the organization.
Components of Income Statement Basics
The basic Components of the Income Statement include the following:
- Revenue: Revenue is the sales or gross receipts of the organization that arrive from the sale of goods or providing of services. The Accuracy of Revenue can be verified by verifying the bills raised. The bills raised for the period should be tallied with the organization’s revenue.
- Cost of Goods Sold: Cost of Goods Sold arrives 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, which can be verified from the corresponding bills. Direct expenses include the expenses related to purchasing, like manufacturing expenses, direct labor, etc., which 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 the cost of goods sold. There are also chances of gross loss if the cost of goods sold exceeds the revenue. It happens when the product’s sale price declines for various reasons.
- Operating Expenses: Operating expenses refer to the expenses incurred out of normal business operations. It includes the Administration expenses, which include 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 include 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 unrelated 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 organization’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 organization’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 contributing to the profit are revenue and cost of goods sold. It is a proforma income statement through which it can be presented better.
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