SIX (6) SECTIONS OF THE INCOME STATEMENT:

Heading: ( first section of the income statement)

The heading outlines the name of the company, the type of statement that follows (in this case, the income statement) and the time frame of the statement. Here is the heading of the company TRY OUR BIKES.

TRY OUR BIKES
Income Statement
For the Period Ending August 31, 200X

The first two lines of the heading are self explanatory. The third line or what we call the time frame line requires further discussion. The time frame is the most important part of the heading, since it tells readers of the income statement the final date at which all revenues and expenses have been calculated. Would the Net Income change if we were to change the time frame? The answer is YES!!! To explain this concept lets create an income statement for TRY OUR BIKES for the month of May only.

To complete this task you would be required to know all the revenues and all operating expenses generated from May 1 to May 31, 200X. Lets assume, during May, 200 customers rented bicycles paying $20.00 each, resulting in a bicycle rental revenue of $4,000 (200 customers x $20). In addition, 100 of the 200 customers rented safety equipment at $10.00 each, resulting in a safety equipment rental revenue of $1,000 (100 customers x $10.00). Also, let say operating expenses from May 1 to May 31 included the following; $1,200 for newspaper advertising, $500 for developing brochures and pamphlets, $2,225 rent, $400 for telephone and other utility expenses, $400 in office supplies (all of which were consumed) $75 interest on a loan you received to open the business, and $150 for company registration. What is the Net Income or Net Loss of TRY OUR BIKES for the period between May 1 and May 31, 200X . Assume an income tax rate of 30%

The Net Income or bottom line for TRY OUR BIKES for the month of May is $175 (IE May 1 to May 31).

As you can see, the time frame (period) is very important. The net income for TRY OUR BIKES is $7,000 from May 1 through to August 31 and the net income for May alone is $175. Remember that May represents only one month of the business's operation while May through August represents four months. Therefore, we can say that in three months, from June through August, the company earned a net income of $6,825 ($7,000 - $175 = $6,825). The authors can not stress enough the importance of timing as it relates to business and finance.

Revenues ( second section of the income statement)
Revenues are inflows of cash and promises of cash (accounts receivable) for goods or services sold to customers. In the example, the TRY OUR BIKE company generates revenue or sales by renting bicycles and safety equipment. Below illustrates the revenue section of the company's Income Statement for the period ending August 31, 200X.

As you can see, the two products being sold have been separated into their own account. Moreover, all sales from bicycle rentals and all sales from safety equipment rentals are calculated separately. This is important because it shows the company which products are generating more revenue. In addition, companies selling many different products, for example, can decide which products are more profitable than others. If one or more of these products are generating insufficient revenues, the company may decide to stop selling and promoting them. For instance, TRY OUR BIKES generated $5,000 in revenue from safety equipment rentals during May through August of 200X. If this revenue is insufficient relative to the cost of purchasing the safety equipment, the company may elect to discontinue the sale (rental) of it.

An important income statement principal you need to understand is known as the revenue reconciliation principal. In the above example, we assumed all customers paid cash for rentals. Many businesses, however, allow their customers the option of buying products or services on credit. If TRY OUR BIKE company granted credit to its customers would the Revenue amount (in dollars) change? The answer is NO!!! The revenue amount in dollars at the end of August would remain at $25,000. In other words, if a customers buys a product or service from a business, the business MUST record the transaction as a revenue or sale immediately. Simply stated; ALL SALES MADE TO CUSTOMERS WHETHER THE CUSTOMER PAYS CASH OR PURCHASES THE ITEM/s ON CREDIT, MUST BE RECORDED AS A SALE OR REVENUE IMMEDIATELY. This rule is very important for you to understand, since you will apply it when developing your forecasted financial income statement.

Operating Expenses ( third section of the income statement)
Operating Expenses are goods or services used or consumed in operating your business. Some examples of operating expenses include advertising expense, office supplies expense, telephone expense, insurance expense, rent expense, accounting fees expense, legal fees, depreciation expense, wage expense, utilities expense, bank charges expense, interest expense, and so on.

Operating Expenses consist of two categories; Marketing (selling) Expenses and Administrative Expenses. Marketing Expenses are expenses that directly relate to the selling of your product or service. Marketing expenses might include; advertising expense, sales force salaries, sales displays expense, brochure and pamphlet development expense, sales promotion expense, and so on. Administrative Expenses are expenses that do not directly relate to the selling of your product or service; however they are necessary in operating the business. Administrative expenses may include; offices salaries expense, office supplies expense, office rent expense, insurance expense, utilities expense, shipping expense, delivery expense, maintenance expense, telephone expense, company registration expense, bank service charges expense, depreciation expense and so on.

As you can see the total marketing expenses ($4,000) are added to the total administrative expenses ($11,000) to arrive at the company's Total Operating Expenses ($15,000).  Keep in mind, expense accounts are developed when needed. For instance, if your business does not rent office space, you will not have an account called office rent expense. Or if your business does not require insurance coverage, then you will not have an insurance expense account. On the other end of the continuum, if your business uses a telephone, you will keep track of all telephone expenses in your telephone expense account. For additional examples of operating expenses, please refer to the section entitled "Operating Expenses".

Earnings Before Taxes (fourth section of the income statement)
Earnings Before Taxes (EBT) is the difference between total revenues and total operating expenses. Furthermore, the sum of all operating expenses are subtracted from the total of all revenues (or gross margin if you have cost of goods sold) to arrive at the Earnings Before Taxes. PLEASE NOTE: the term taxes, refers ONLY to the income tax a company would pay on its income made - it's similar to the income taxes paid on employment income. Furthermore, it does NOT refer to property tax, sales tax, municipal tax, or any other type of tax a business might be obligated to pay.

Income Taxes (fifth section of the income statement)
Businesses, like individuals, must pay income taxes based on their taxable income. The tax a company pays consists of state (provincial) and federal taxes and is calculated using a percentage (%) based on a company's Earnings Before Taxes. Most businesses have an accountant calculate their tax obligation. Individuals not owning a business and who are required to prepare forecasted financial statements find it difficult to decide on a tax percentage to apply to their EBT. Since these people are not accountants or tax experts, this seems to be a legitimate concern.  When preparing forecasted financial statements, many business plan writers assume an income tax rate of 20% or 30%.

Net Income (sixth section of the income statement)
Net Income is calculated by subtracting the dollar amount appearing in income tax account from the Earnings Before Tax. In other words, your Net Income is really your earnings AFTER taxes. There is a major misconception when it comes to the term Net Income. Many people believe Net Income is cash they have in the bank. This simply is not true. The cash account, shown on your Balance Sheet (which will be discussed later), depicts the amount of cash that's in a company's bank account. Furthermore, the Net Income, which at one time was cash, is used to buy assets, pay down debts, purchase inventories, pay dividends (if any), and pay the owners.

This concludes the six major components of the Income Statement. Be sure you understand each component since they are needed to develop a forecasted income statement. These issues will be discussed in greater detail as you proceed, so don't get discouraged. There's one extremely important income statement item you should be aware of.  It's known as "Cost of Goods Sold".  You should click your BACK button to review it now.