Imagine your business as a bustling kitchen. You, as the chef, face different challenges to create your dish: you need ingredients, you have to get the timing right, and you need to make sure the quality satisfies your customers’ tastebuds.
This is where the traditional income statement comes in. It’s like a recipe book for solving chef’s problems in the kitchen. Not only can you find the missing step in the process, but also discover the secret ingredients that will help make your small business flavorful and appetizing.
In this article, we’ll help you explore why this financial document is a business game-changer and how will it guide you in making the best financial decisions to achieve your goals.
What is an Income Statement?
An income statement, as we said earlier, is a financial recipe book. It shows you how much your business makes, how much you are spending, and how much is left over as your profit.
The income statement is a tool to help you know if your business is doing well, based on a specific period, like a month or a year. It also pinpoints which parts you need to modify to reduce spending and increase your earnings.
Components of a Traditional Income Statement
Here is a quick run-through of the elements you can find in a traditional income statement:
Sales Revenue: the total money that comes in from selling something to your customers
Cost of Goods Sold (COGS): the amount you spent for producing the items you sell including administrative expenses like rent, utilities, and equipment
Gross Profit: the money left after subtracting COGS from your revenue
Operating Expenses: daily costs of running a business like rent, utilities, direct labor, and salary
Operating Income: the amount that remains after operating expenses are subtracted from the gross profit
Interest and Taxes: any extra money received or additional costs incurred which are not part of the main business activities like interest, taxes, and other fees
Net Income: what you have left after all expenses are taken away from all earnings acquired
Traditional vs. Variable Income Statements
Traditional (Absorption Costing) Income Statement
The traditional income statements use absorption costing/ full costing that considers both variable and fixed expenses in the computation. It includes the fluctuating production costs and fixed manufacturing costs in calculating the cost of goods sold like insurance, salaries of workers, and other selling and administrative costs.
Variable Income Statements
In contrast, the “non-traditional” one is the variable income statement. This is also called a contribution margin income statement. It is a financial computation of profit that separates variable costs from fixed costs. Contribution margin income statements use variable costing where fixed production costs are included in overhead costs. The cost of goods sold only includes the variable expenses directly tied to production without the fixed cost because it does not affect the sales volume.
For this article, we’ll focus on traditional income statements which lets us look at the big picture. As a business owner, this income statement gives you an idea of the company's overall positive or negative business profit. It is also used for external company reporting like investors and government regulatory financial reports.
Is a Traditional Income Statement Beneficial for My Business?
Having a traditional income statement is not just a way to comply with annual income taxes and other business regulations, but also gives you other valuable uses like:
With 1 in 5 businesses failing in its first year (1), you need a guide in your financial planning. Having a precise income statement lets you set clear business objectives because it offers complete revenue and expense information.
Simplified Tracking of Business Performance
It lets you make well-informed decisions as you monitor the historical progress of income and expenses against your overall budget. It helps you to calculate gross profit, applicable fixed costs, variable production costs, and income tax amongst others.
Attracting More Investors
It demonstrates your company’s financial health so investors can easily gauge and assess your business profitability and growth potential.
Boost Your Funding Applications
Did you know that the average loan amount of a small business amounts to $100k? (2) Building trust with your lenders is important to help you boost your funding applications. With an income statement, you can provide potential sponsors and financial institutions with an overview of your ability to pay which to help you secure loans for operation and expansion.
We get it, preparing a traditional income statement can be REALLY overwhelming, especially when you’re not sure how to interpret the information you’ve compiled.
However, the value of having an Income Statement is much higher than the effort of compiling it and understanding how to use it. At Hall Accounting Company we’ve committed ourselves to helping our small business clients.
Seek Help From Our Team of Expert CPAs
Hall Accounting is your solution to maintain an accurate traditional income statement for your business. Our team of expert CPAs will simplify your financial reporting process and help you grasp where your business stands financially without the steep learning curve of doing it by yourself.
From daily bookkeeping tasks to compiling your financial statements and even up-to-date planning and financial projections, we’ll guide you in tailor-fitting answers to your business's financial needs, like a chef gauging the readiness of their dishes.
Book a call with us today! Let’s work together to craft your financial statements and continue to whip up business success.