Of course profit and cost of goods sold expense are the two most critical components of an income statement, or at least they're what people will look at first. But an income statement is truly the sum of its parts, and they all need to be considered carefully, consistently and accurately.
In reporting depreciation expense, a business can use a short-life method and load most of the expense over the first few years, or a longer-life method and spread the expense evenly over the years. Depreciation is a big expense for some businesses and the method of reporting is especially critical for them.
One of the more complex elements of a an income statement is the line reporting employee pensions and post-retirement benefits. The GAAP rule on this expense is complex and several key estimates must be made by the business, such as the expected rate of return on the portfolio of funds set aside for these future obligations. This and other estimates affect the amount of expense recorded.
Many products are sold with expressed or implied warranties and guarantees. The business should estimate the cost of these future obligations and record this amount as an expense in the same period that the goods are sold, along with the cost of goods expense. It can't really wait until customers actually return products for repair or replacement, should be forecast as a percent of the total products sold.
Other operating expenses that are reported in an income statement may also have timing or estimating considerations. Some expenses are also discretionary in nature, which means that how much is spent during the year depends on the discretion of management.
Earnings before interest and tax (EBIT) measures the sales revenue less all the expenses above this line. It depends on all the decisions made for recording sales revenue and expenses and how the accounting methods are implemented.
While some lines of an income statement depend on estimates or forecasts, the interest expense line is a basic equation. When accounting for income tax expense, however, a business can use different accounting methods for some of its expenses than it uses for calculating its taxable income. The hypothetical amount of taxable income, if the accounting methods used were used in the tax return is calculated. Then the income tax based on this hypothetical taxable income is featured.
This is the income tax expense reported in the income statement. This amount is reconciled with the actual amount of income tax owed based on the accounting methods used for income tax purposes. A reconciliation of the two different income tax amounts is then provided in a footnote on the income statement.
Net income is like earnings before interest and tax (EBIT) and can vary considerably depending on which accounting methods are used to report sales revenue and expenses. This is where profit smoothing can come into play to manipulate earnings. Profit smoothing crosses the line from choosing acceptable accounting methods from the list of GAAP and implementing these methods in a reasonable manner, into the gray area of earnings management that involves accounting manipulation.
It's incumbent on managers and business owners to be involved in the decisions about which accounting methods are used to measure profit and how those methods are actually implemented. A manager can be requires to answer questions about the company's financial reports on many occasions. It's therefore critical that any officer or manager in a company be thoroughly familiar with how the company's financial statements are prepared. Accounting methods and how they're implemented vary from business to business. A company's methods can fall anywhere on a continuum that's either left or right of center of GAAP.
Need help with your bookkeeping? Each and every bookkeeper on The Bean Counters Bookkeeping team holds degrees in accounting. We provide basic through top-brass services to help your business realize bigger profits. Give us a call for a free consultation.
The first and most important part of an income statement is the line reporting sales revenue. Businesses need to be consistent from year to year regarding when they record sales.
For some business, the timing of recording sales revenue is a major problem, especially when the final acceptance by the customer depends on performance tests or other conditions that have to be satisfied.
For example, when does an ad agency report the sales revenue for a campaign it's prepared for its client? When the work is completed and sent to the client for approval? When the client approves it? When the ads appear in the media? Or when the billing is complete? These are issues a company must decide on for reporting sales revenue, and they must be consistent each year, and the timing of reporting should be noted on the financial statement.
The next line in an income statement is the cost of goods sold expense. There are three methods of reporting cost of goods sold expense. One is called "first in-first out" (FIFO); another is the "last in-last out" (LIFO) method and the last is the average cost method. Cost of goods sold expense is a huge item in an income statement and how it's reported can make a substantial impact on the reported bottom line.
Other items in an income statement include inventory write-downs. A business should regularly inspect its inventory carefully to determine any losses due to theft, damage and deterioration, and to apply the lower of cost or market (LCM) method. Bad debts are also an important component of the income statement. Bad debts are those owed to a business by customers who bought on credit (accounts receivable) but are not going to be paid. Again the timing of when bad debts are reported is crucial. Do you report it before or after any collection efforts are exhausted?
Keep an eye out next week for Parts of an Income Statement Part 2.
Inventory is usually the largest current asset of a business that sells products. If the inventory account is greater at the end of the period than at the start of the reporting period, the amount the business actually paid in cash for that inventory is more than what the business recorded as its cost of good sold expense.
When that occurs, the accountant deducts the inventory increase from net income for determining cash flow from profit.
The prepaid expenses asset account works in much the same way as the change in inventory and accounts receivable accounts. However, changes in prepaid expenses are usually much smaller than changes in those other two asset accounts.
The beginning balance of prepaid expenses is charged to expense in the current year, but the cash was actually paid out last year. this period, the business pays cash for next period's prepaid expenses, which affects this period's cash flow, but doesn't affect net income until the next period.
As a business grows, it needs to increase its prepaid expenses for such things as fire insurance premiums, which have to be paid in advance of the insurance coverage, and its stocks of office supplies.
Increases in accounts receivable, inventory and prepaid expenses are the cash flow price a business has to pay for growth. Rarely do you find a business that can increase its sales revenue without increasing these assets.
The lagging behind effect of cash flow is the price of business growth. Managers and investors need to understand that increasing sales without increasing accounts receivable isn't a realistic scenario for growth. In the real business world, you generally can't enjoy growth in revenue without incurring additional expenses.
Need help figuring out the confusing world of accounting? If you're planning on growing your business in the new year, we'd love to help! Contact us for a free consultation.
The best way to keep your business going long term and to experience more success is to continue to grow and expand. If you’re not growing and expanding, you’re stagnating. There are many ways in which you can experience continuous growth and expansion in your business and your life.
Start a Joint Venture Partnership
Get out of your comfort zone and work on a project with someone you might normally see as a competitor. If you know someone who promotes complementary products and/or services to yours, get on board with them to promote something jointly. The more often you participate in JVs, the more you’ll expand awareness of your business and offerings.
Create More Products or Services
Diversifying your offerings can help you expand and grow, too. For example, if you currently offer groups or online courses on how to do something, you can expand to offering one-on-one coaching services to delve even deeper than your current offering does. Plus, you can charge more money.
A fast way to grow and expand is to simply get more clients. Of course, you’re only one person so you might need to outsource more work to others to ensure that you can accommodate more customers and clients.
Teach What You Know to Others
If you have a skill that you can share with others to teach them to become successful like you, don’t keep it to yourself. Share it. You won’t create more competition even if you think that will happen. Instead, you’ll not only get more customers, but you’ll also be seen as more of an expert.
Write a Book
If you’re already an expert in something, the way to expand your expertise is to write a book on the topic. Then, use the book to promote your other products and services. You’ll earn from the book and from the added promotional opportunities the book provides.
Get on the Speaking Circuit
Once you have a book, a course, and a coaching program, you can easily get on a speaking circuit. Through paid speaking engagements you can get the word out about your business to a lot of people and finally solidify your expertise.
Be Consistent and Persistent
If your business is already growing and expanding, keep doing what you’re doing. At the end of the day, consistency and persistence pay off for every business model.
Network More Efficiently
Take a look at how you go about networking, and who you’re networking with. You want to network strategically with potential joint venture partners, potential customers, as well as colleagues.
Enlist the Help of Professional Bookkeeping and Accounting Services
Many businesses fail to grow because they do not keep accurate records for every aspect of their business. Without accurate bookkeeping and accounting, your business will suffer and eventually fail as it will have no records or projections to help it progress. Our entire team hold degrees and are fully qualified to help you fill the need for proper accountancy in your business. Please contact us for a free consultation.
Growing and expanding requires self-awareness of what you are doing and what you’re not doing to move forward. Occasionally assess your goals to ensure that you are on track to be where you envisioned you would be at a specific time. If you’re succeeding, keep on doing what you’re doing. If you’re behind, it’s okay; you just need to adjust.
One way to make collecting on invoices easier is to set up an automated invoicing system. Or, you can use invoicing systems that work with email and PayPal. Thankfully, today there are so many systems that you can surely find the right one for you.
In the “old days” you had to wait for a check to arrive in the mail; today you can use many different payment processors like PayPal, ACH, Stripe.com, and more.
Problems with Invoicing
Some of the most difficult aspects of invoicing are:
* Getting accurate invoices out on time – A real key to invoicing is to make accurate invoices that include all the work done up to the point of the invoice. Without a good system, you could forget work that you’ve done.
* Following up when payment is overdue – Sometimes payments are late; sometimes it’s the client’s fault and sometimes it’s your fault due to the invoice not showing up. You can’t know if you’re not paying attention and following up.
* Tracking payment to the right invoice – If you do manual invoicing and manual data entry, you may accidentally credit the wrong payment to the wrong invoice. Ask clients to include the invoice number on the check, or switch to an automatic invoicing system where your clients can click to pay their invoice online.
Here are some software solutions that can help.
* FreshBooks – This is a terrific invoicing software solution that allows you to accept several different ways of collecting payment. You can even mail an invoice through snail mail, or send through email. It has time tracking, expense tracking and many other features that help create accurate invoices automatically.
* QuickBooks – A professional solution that works in many ways, from allowing you to set up recurring payments, to sending one-time invoices, to collecting payment via ACH automatic deposit to your business account.
* PayPal Invoicing – You’ll have to make each invoice individually as it doesn’t have any auto features, but it’s free and included with your PayPal business account. It’s also easy to use and looks professional with your business logo included on the invoice.
* Recurring/Subscription Payments – Seek software that enables you to invoice and collect payment on a recurring basis. This way you don’t have to do it manually each month, which will be a huge time saver.
Using these systems can go far in helping you eliminate busy work when it comes to getting invoices out on time, accurately, and in a professional manner that demands payment without being rude or intrusive.