Preparing an Income Statement

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Income Statement Basics

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Income statements are also known as Statements of Profit and Loss or P&Ls. The Income Statement reflects revenue and all expenses incurred in the production of that revenue for a specific amount of time. For example, the Twelve Month Period Ending December 31, 20XX or the One Month Period Ending May 31, 20XX.

There are three types of arts and crafts businesses and each one will have a slightly different looking income statement:

  1. Service - examples of services type arts and crafts businesses are those that provide design, layout or other type of non-product related help to other businesses. Your business may do the artwork for another business' brochure.
  2. Merchandising - this is an arts and crafts retail business. A merchandiser purchases goods from a manufacturing business and in turn sells them to the end user - a consumer like you or me.
  3. Manufacturing - as the name implies the arts and crafts business makes the tangible products that are sold.

You can roll one type, two types or all three types in the same business. As an example, if you make jewelry and sell it through a website, you're both a manufacturer and a merchandiser. If you dye fabric to sell to clothing designers, you're a manufacturer. If you sell artwork to a handmade greeting card designer and silk-screen your own artwork on t-shirts you sell at crafts shows, you're all three types.

In order to effectively and efficiently run their business every business owner should have a basic knowledge of how an income statement is prepared. The income statement is a valuable tool in profitability analysis, estimation of income taxes payable and to obtain funding for the business. In this tutorial, I'll show you how to prepare an income statement regardless if you're a service, merchandising or manufacturing type of business.

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Income Statement Sections

Sections of an Income Statement.

The income statement consists of four different sections, the heading, sales, cost of goods sold and general & administrative expense. Regardless which type of arts and crafts business you own, your income statement shows sales, manufacturing and merchandising businesses will have a cost of goods sold and all three types will have general and administrative expenses.

Items to note:

  • Gross Profit is what is left over after the Cost of Goods Sold (COGS)is subtracted from Net Sales.
  • Total Expense = COGS + General and Administrative Expense
  • Net Income is your profit after all business expenses have been accounted for.

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Service Business Income Statement

Service Business Income Statement.

If you operate an arts and crafts service business, you won't have a cost of goods sold. Why? It's because the true value of what you provide in your business is a thought or idea rather than a tangible product. For example, if I provide just the jewelry designs to a jewelry manufacturer, I operate an arts and crafts service business.

True, I provide the designs to the manufacturing company on a DVD and this is a tangible product - but the manufacturer is not paying for the relatively de minimis cost of the DVD; they are paying for the intellectual product provided on that electronic media.

If you operate a arts and crafts service business look to your Salary Expense to measure whether or not the business is operating effectively and efficiently. In this example, revenue is twice that of salary expense. The relationship between revenue and salaries is pretty standard.

However, this is a relative opinion. In actual practice, you might not be satisfied with one month's Net Income of $3,300. But, how about if you’re the only employee. Would you be happy with take home income (before taxes) of $8,300?

Another income statement application is to use it as the starting point to determine what the effect would be on revenue and net income if you were able to take on more projects by hiring more employees. Keep in mind that’s predicated on the fact that you’ll be able to find the work to keep the additional employees busy and the skill level of new employees would also have a material effect on revenue.

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Merchandising Business Income Statement

Merchandising Income Statement.

In addition to sales and general and administrative expenses, an arts and crafts merchandising business income statement includes a cost of goods sold. As a merchandiser, you'll be buying your arts and crafts products from other companies so you won't have any raw material or labor costs.

Here's an explanation of the different components:

  • Beginning Inventory - merchandise you have in your arts and crafts retail shop at the beginning of the month available for sale.
  • Purchases - merchandise you buy during the current month. Beginning inventory plus purchases are your goods available for sale to customers.
  • Ending Inventory - merchandise you have in your arts and crafts retail shop at the end of the month that has not yet been purchased by your customers.
  • Goods available for sale minus ending inventory equals your cost of goods sold

Merchandising businesses also include as cost of goods sold any freight-in or storage costs you can directly tie to merchandising the product. Let's say you have to rent a storage unit for your overflow inventory. That also goes into your merchandising cost of goods sold. As a general rule all other expenses - even those of your sales staff - go in general and administrative expenses.

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Manufacturing Business Income Statement

Like the merchandising arts and crafts business, a manufacturing business income statement will have revenue, cost of goods sold and general and administrative expenses. However, the cost of goods sold section for a manufacturing business is more complicated.

When you manufacture your goods, additional elements enter into the cost. You'll have material costs, and the associated labor and overhead costs to convert raw material to a finished good. A manufacturing company has three inventories rather than one: raw materials, goods in process, and finished goods.

  1. Raw materials consist of all the items you buy to make your arts and crafts products. For example, a clothing designer will have fabric, notions and patterns.
  2. Work in process are all your items that you are in the middle of making at the end of the financial period. For example, if the clothing designer has five dresses in various stages of completion, work in process is the value of those five dresses.
  3. Following along in that same line of logic, the value of all completed dresses that are not yet sold to merchandisers are included in your finished goods inventory.