How to Prepare Income Statement
In order to prepare income statement, certain process should be followed. This process covers the following steps:
- Gather financial data: The first step in preparing an income statement is to gather all of the relevant financial data, including revenues, expenses, and other income and expenses.
- Organize the data: Once the financial data has been collected, it needs to be organized into appropriate categories. This may involve grouping expenses by type (e.g. salaries and wages, rent, utilities, etc.) and revenues by source (e.g. product sales, service fees, etc.).
- Calculate gross profit: The next step is to calculate gross profit, which is the difference between total revenues and the cost of goods sold (cost of services provided). Gross profit amount provides an indication on how much profit the company is generating from its core business operations.
- Calculate operating expenses: After calculating gross profit, the next step is to calculate operating expenses. For this purposes it is needed to add all of the expenses, which are not directly related to the cost of goods sold (cost of services provided). These expenses usually include salaries, rent, maintenance, utilities, marketing and other general and administrative expenses.
- Calculate operating profit (loss): Once gross profit and operating expenses have been calculated, the next step is to calculate operating profit (loss, if it is negative). This is done by subtracting operating expenses from gross profit.
- Calculate other income and expenses: In addition to operating profit (loss), there may be other income and expenses, which need to be accounted for. The examples can be interest income, interest expenses, gains or losses on investments and other income (expenses) related to non-core activities of the business.
- Calculate income before taxes: Once all of the income and expenses have been accounted for and included into the income statement, the next step is to calculate income before taxes. This is a difference between operating profit (loss) and results from other activities.
- Calculate income tax expense: After calculating income before taxes, the next step is to calculate income tax expense. This is done based on income before taxes, however local tax rules and tax rates have to be applied. These rules might be different in different countries.
- Calculate net income: Once income tax expense has been calculated, the final step is to calculate net income (loss). This is done by subtracting income tax expenses from income (loss) before taxes.
- Prepare the income statement: The final step in the income statement preparation process is to prepare the income statement. This involves presenting the financial data in a clear and structured format. Usually it is done in a table format, showing each caption of the income statement. Income statement also may include additional information, such as earnings per share or other financial performance indicators.
Why it is important to prepare income statement regularly?
Regularly creating income statements is essential for businesses and individuals for several reasons:
- Monitor financial performance: Income statements allow businesses to monitor their financial performance over a specific period of time. Regularly creating income statements can help identify trends, both positive and negative, in revenue, expenses, and profits, which allows to make timely adjustments in the business development and management process.
- Evaluate profitability: Income statement provides proper measure of a business profitability by comparing revenues to expenses. Regular preparation of income statement can help businesses identifying areas, where profits are generated and where improvements are needed.
- Facilitate financial decision-making: Income statement can provide valuable information, which can be used to make informed and supported financial decisions. By analyzing the financial implications of different decisions, businesses can determine, which actions are likely to be profitable and which should be avoided.
- Comply with regulations: Many regulatory bodies require businesses to regularly report financial information, including income statements. Regular preparation of income statement helps ensuring, that businesses are complying with relevant regulations, can avoid penalties and legal issues related to financial reporting.
- Secure financing: Lenders and investors often require businesses to provide financial information, including income statement, as part of the loan or investment approval process. Regular preparation of income statements can help businesses demonstrating their financial health and secure required financing.
Regular preparation of income statement is critical for monitoring financial performance, evaluating profitability, facilitating financial decision-making, complying with regulations, and securing financing. It is an essential tool for businesses and individuals to make informed and supported decisions on the investments and business management.