Definition: Income Statement provides a significant outlook on business health and its profitability. It communicates information on producing and selling actions of a business over an extent of time. However, it won’t show the whole picture of the financial health of a company, the report on the assets, liabilities and equity of the company is shown in its balance sheet, and the report of the movement of cash is shown in the cash flow statement.
An income statement helps the entrepreneur to determine the clear picture of the business whether it has chances of growth in future or not. The amount of income can be calculated with the following formula:
Content: Income Statement
- How to prepare Income Statement
- Headings of Income Statement
- Format of Income Statement
- Example of Income Statement
- Importance of Income Statement
How to prepare Income Statement
The following are the guidelines to be followed for preparing the Income statement:
- Step 1: Make the heading as Income Statement of XYZ Ltd for the year ended DD/MM/YYYY.
- Step 2: Organize the accounts according to the significance of the information or according to the amount (put a higher amount of transactions first).
- Step 3: Then enter all other income or expense accounts as the concluding account in every part.
- Step 4: Left the space for the signature of the responsible person after every line.
- Step 5: Make a single line after every arithmetic entry and a double line before the net income or net loss.
Headings of Income Statement
The following information is inclined in the headings of the income statement:
- Company’s name for which it has to be prepared.
- Name the statement as an income statement.
- Mention the year for which the income statement is prepared.
Format of Income Statement
For the year ended 31/12/2019
|(A) Net Sales||xxx|
|(B) Cost of Goods sold||(xx)|
|(C) Gross profit on sales (A-B)||xxx|
|(D) Operating expenses|
|(E) Net income from operations ( C-D)||xxx|
|(F) Other income|
|(G) Total Operating income (E+F)||xxx|
|(H) Income Tax||(xx)|
|(I) Net Income (G-H)||xxx|
Example of Income Statement
The following are the items of ABC Ltd for the year ended 31/12/2019. Prepare an Income statement from the given details:
- Sales return and allowances-8000
- Sales discount-1500
- Opening stock-70000
- Purchase return and allowance-6500
- Purchase discounts-800
- Freight inwards- 3800
- Closing stock-95000
- Rent paid-6000
- Insurance expense-3500
- Freight outward-700
- License expenses-150
- Telephone expenses-400
- Light expenses-1200
- Miscellaneous expenses-1800
- Rent Received-4500
- Commission received-1700
- Interest paid-1600
- Income tax-8600
For the year ended 31/12/2019
|(A) Net Sales:||1,87,000|
|(-) Sales Return||(8000)|
|(B) Cost of Goods Sold||(56,500)|
|(+) Net Cost of Purchase||85000|
|(-) Purchase Return and Alollwance||(6500)|
|(-) Purchase Discount||(800)|
|(C) Gross Profit on Sales (A-B)||1,30,500|
|(D) Operating Expenses||(33650)|
|(E) Net Income From Operations( C-D)||96,850|
|(F) Other Income||6200|
|(G) Other Expenses|
|(H) Total Operating and Other Income(E+F-G)||101450|
|(I) Income Tax||(8600)|
|Net Income (H-I)||92850|
Importance of Income Statement
Basically, we care about the income statement because it shows the profitability of a company. We have an example of some things that could go on here, which would make you question and make it difficult to see whether a company is profitable or not?
So, in our example, we have a company of retail clothing.
|Purchases||1,50,000||Nil (Closing Stock)|
|Loan ( To be repaid in 3 years with 5 % interest rate)||2,00,000||Nil|
(Must be replaced in 10 years)
In the above example, the company has a sale of ₹ 1,60,000 in 2018 and ₹ 1,80,000 in 2019 and bought a stock of ₹ 1,50,000 for the year 2018 and machinery of ₹ 50,000 for the business. It is seen that in 2018 the company purchases an inventory of ₹ 1,50,000 and in 2019 no inventory was bought by the company. So presumably in 2020, it has to buy more inventory. So, the question that arises here is, is this company going to be not profitable in 2018 because it has spent most of its sales in inventory and in 2018, or it is going to be really profitable because it hasn’t bought any inventory and have lots of sales. And, then 2020 would be another bad year because it has to buy inventory. We will see how it works in an income statement.
In 2018 they took out a loan of ₹ 2,00,000, is that a bad thing, because it has a loan or it is a good thing because suddenly you have ₹ 2,00,000 in cash. How does it affect profitability? Another thing that can be going on in 2018 is that they bought the machine of ₹ 45,000 which has to be replaced in 10 years. Again, a question arises here, does it make 2018 a loss-making year and then the next 4 years will be good and then suddenly 2022 we won’t make any profit because we have to replace the machinery.
How do we see if the company is truly profitable?
One thing is that we should not give more emphasis on the timing of an inventory purchase and determine whether the company is profitable or not. It should not make any difference when the inventory is purchased in a year. So, notice when we go to the income statement, what we are looking for is the cost of goods sold. We are only working at how much we had to spend in order to the goods that we sold and not a particular year, not the goods that we bought in stock in inventory.
Now, do we care about inventory?
Yes, definitely it has to be entered in the balance sheet and we look out it in a statement of cash flows, but to see if a company is profitable or not, we don’t need an inventory. We are a clothing retailer, so we are going to say 100% markup which will be too unusual at all, which means that when we sold ₹ 1,60,000 clothing in 2018, that clothing will cost us ₹ 80,000. We then mark it up 100%, and it became worth 1,60,000. We don’t care that we bought an inventory of ₹ 1,50,000. We care that the clothes that we are sold cost us ₹ 80,000. In the same way, in 2019 100% markup means that it costs ₹ 90000 to produce 1,80,000 worth of clothes.
Then, we get gross profit after subtracting the cost of goods sold, after then subtract depreciation of the machinery which we purchased in 2018 (it should be depreciated every year for 10 years by ₹ 5000 as it has to be replaced after 10 years. After that subtract all other operating expenses incurred to get an operating profit and then the interest amount paid for the loan, we have taken should be deducted from it to get the profit before tax. And finally, after that deduct, the amount of income tax and we will get the amount of net profit/ loss earned by the company. This can be summarized by the below income statement to understand it more precisely.
|(B) Cost of Goods Sold||(80,000)||(90,000)|
|(C)Gross Profit (A-B)||80,000||90,000|
|(D) Operating Expenses|
|(E) Net Operating Profit ( C-D)||55,000||65,000|
|(F) Interest Paid on loan||(30000)||(30000)|
|(G) Net Profit Before Tax (E-F)||25,000||35,000|
|(I) Net Profit After Tax(G-H)||9,500||27,400|
So, what we have done here is take a bunch of information that occurs at different times. We could manipulate intentionally by changing some date around and so on and enter it in a systematic way to answer the question is this company at the end of the day profitable? Remember this is the income statement; there is going to be other things going on that are very important.
Thus, here we conclude that this company appears to be profitable.
An income statement is nothing but a profit and loss statement of the company showing all the expenses and incomes incurred during the year to get the net profit/ loss.