Finance Essentials: Income Statement

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The Income Statement shows the profitability of the company over a period of time and it starts with the sales revenue. Often entrepreneurs without financial knowledge mistake revenue with income. Income is at the bottom of the statement and it is calculated by deducting the costs from the sales revenue. To avoid such mistakes lets find out more details about the Income statement in the article below.

Below sales revenue is the cost of sales – the direct costs that incur to make the products. This line includes the materials used for building the product, the labor for putting the materials together, the freight costs for delivering the finished products and basically all production and transportation costs that could be assigned to a specific product. Not all businesses have direct costs – some service businesses don’t have direct costs, so they have a gross margin of 100 percent. A lot of services do have direct costs though. For example, freight companies have gasoline costs, truck maintenance costs, drivers’ salaries etc.

When you subtract your costs of sales from your revenues, you arrive at your gross profit. Gross profit margin represents the percentage of that profit measured against the sales number. This margin is so important, since it shows relatively what part of the revenue is available for supporting costs of the business, and of course how much room for business growth is left. General rule is that the higher the margin percentage is, the better, but it really depends on the industry of the business as well.

The next line on the income statement are the operating expenses. It contains all the cost for business support – administrative costs, sales costs, marketing costs, research and development costs etc. It is important to keep these costs under control. To do that you should be able to split them into specific important components for your business and tend not to use general expense items.

Deducting the operating expenses from the gross margin you arrive at your operating profit, your profit from business operations.

Next lines include the corporate tax due and interest expenses. And when you subtract them from your operating income you get to your net income. This is the net number that your business made and is available to you, to pay as dividends or reinvest it back.

Both operating and net income are reviewed as margins as well, measured against the sales number. Again we should mention that these margins are relative to other companies in the same industry. If your business is in Fast-Moving Consumer Goods industry and you compare your margins to IT company you will be left with the impression that your company is having bad results, when in fact the reality could be different.

On first glance all the information from the income statement could look overwhelming, but it is really important for you as an entrepreneur to be aware what each line of the income statement means and consists of, to be able to manage and plan your business successfully.

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