Unit 12: Financial Forecasting

Lesson 2: Income Statement Preparation

Contents
Engage 1
Introduction 1
Objectives 1

Explore 2

Explain and Elaborate 3

Introduction to Income Statement 3
Purpose of Income Statement 4
Income Statement Formula and Preparation 5

Extend 8
Activity 8

Evaluate 9

Wrap Up 12

Bibliography 13
Unit 12.2: Income Statement Preparation

Engage

Introduction

Fig. 1. Income Statement preparation

Financial statements are used by entrepreneurs and investors for different reasons and
purposes. These statements come in different forms that are generally used to analyze the
finances of a business. Also referred to as an earnings statement, the income statement
highlights the financial performance of a business for a certain period of time. It aims to
compute for the net profit or loss incurred by the business for a certain accounting period.
This lesson will deeply tackle the concept and purpose of an income statement, as well as
the steps involved in its preparation.

Objectives
In this lesson, you should be able to do the following:
● Identify the concept and purpose of income statements.
● Understand the steps involved in income statement preparation.

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Unit 12.2: Income Statement Preparation

DepEd Competencies
● Forecast the revenues of the business. (CS_EP11/12ENTREP-0h-j-14)
● Forecast the costs to be incurred. (CS_EP11/12ENTREP-0h-j-15)
● Compute for profits. (CS_EP11/12ENTREP-0h-j-16)

Explore

Guide Questions
Answer the following questions briefly and coherently:
10 minutes

1. What do you think is the main objective of establishing a business?

2. What is the reason why most startup businesses incur losses in the beginning?

3. How much is your preferred monthly income if you will start your own business?
Explain.

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Unit 12.2: Income Statement Preparation

Explain and Elaborate

Introduction to Income Statement

Fig. 2. Financial Records

An income statement, otherwise known as the profit and loss statement, is a detailed
report that shows all the income or earnings, expenses, and the resulting profits or losses of
a business for a given accounting period. This is the primary financial statement that must
be prepared because the resulting net income or loss incurred by the business must be
calculated before preparing other financial statements.

The calculations made in an income statement shows potential investors the overall
financial performance and profitability of the business, most especially the efficiency of the
business in generating profits from its total revenues. In contrast to the balance sheet, the
income statement focuses on net income or loss over a range of time. In short, yearly
income statements use revenues and expenses incurred over a 12-month period, whereas
quarterly statements use revenues and expenses incurred for a 3-month period.

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Unit 12.2: Income Statement Preparation

Purpose of Income Statement

It has to be remembered, however, that different types of income statements are used for
various reasons. The annual income statement is prepared yearly for stockholders and
potential investors of the business. There are those who also prepare interim financial
statements so that the management will be able to check the status of business operations
during the year. In some cases, departmental statements are likewise used to be able to
assess the revenues and expenses of a certain business segment. But in the end, the main
purpose of an income statement is to communicate the profitability and all activities of the
business with its end-users, stockholders, and investors.

There are two groups of people who use an income statement - internal users and external
users. Internal users are composed of people who are in charge of the business as well as
the board of directors in big corporations. These people use the income statement to
analyze the performance of the business and to be able to make effective decisions. For
example, the calculations or estimates shown in the statement will allow them to gauge
whether it is better to expand the business, close a department, make new product lines,
and so forth.

On the other hand, external users are composed of the investors and creditors of the
business. These people are the outside forces in the business who are indirectly related to
its operations. Investors are interested in the income statement of the business, for they are
mainly concerned about whether or not investing their money in the business will yield
positive returns or not.

Remember
An income statement, also known as the profit and loss
statement, is a detailed report that shows all the income or earnings,
expenses, and the resulting profits or losses of a business for a given
accounting period.

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Unit 12.2: Income Statement Preparation

Income Statement Formula and Preparation

Since the income statement is meant to measure the performance of a business with
respect to its revenues and expenses, the formula is:

Revenues - Expenses = Income or Profit (Loss)

In summary, from the forecasted revenues of the business, the entrepreneur has to deduct
the estimated cost of goods sold. The difference between those two should give the gross
profit of the business. The operating expenses must then be subtracted from the gross
profit to arrive at the operating profit. Afterward, the taxes due are then subtracted to
determine the net profit after taxes.

Example: Income Statement

Income Statement of Juan Dela Cruz Inc.

For Year Ended December 31, 2019

Gross Sales P650,000

Less: Cost of Goods Sold 300,000

Gross Profit/Margin 350,000

Less: Operating Expenses 100,000

Operating Profit/Margin 250,000

Less: Taxes Due 20,000

Net Profit after Taxes P230,000

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Unit 12.2: Income Statement Preparation

Parts of Income Statement

1. Gross Sales or Sales Revenue

Every income statement would always start with the business’s gross sales or revenues.
The approach to be taken in calculating this figure will depend on the accounting method
adopted by the business and how it assesses its overall revenues.

Generally, gross sales represent the total revenue generated by the business for
whatever period of time is covered by its income statement. For instance, in the sample
income statement shown, the time period is the year ending on December 31, 2019.

2. Cost of Goods Sold (COGS)

The cost of goods sold refers to the direct costs associated with producing all of the
products and/or services sold by the business.

COGS comprises all direct expenses incurred, such as raw materials, labor fees, and
shipping costs. In the case of a milk tea shop, its cost of goods sold would include the cost
of raw tea leaves, sugar, milk, and the packaging used for the product.

When calculating the cost of goods sold, the cost of producing products or services that
are not sold by the business must not be included in the calculation. In essence, COGS
does not include indirect expenses, such as overhead costs, utility expenses, marketing
or advertising expenses, rental expenses, and so forth.

Can you think of examples that would fall under

the cost of goods sold (COGS)?

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Unit 12.2: Income Statement Preparation
3. Gross Profit/Margin
Gross profit/margin is derived from subtracting the total cost of goods sold from the sales
revenue. This variable of the income statement manifests the profitability of the business
after taking into account the direct costs incurred, i.e., the costs associated with making
and selling its products, prior to subtracting its overhead costs.

In short, gross profit is one of the variables that analysts use to be able to assess the
financial health and performance of a business by calculating the amount of money that
was left from product sales after deducting its cost of goods sold.

4. Operating Expenses
Also referred to as general expenses, operating expenses mainly include rent or lease,
bank fees, equipment or machinery expenses, marketing and advertising expenses, and
all other expenditures to keep the business going. In some cases, income statements
group these similar expenses into one broad category called “Selling, General, and
Administrative Expenses.”

5. Operating Profit/Margin
The operating profit in an income statement reflects the residual income after deducting
all expenses or costs of doing business, excluding deductions of interests and taxes. Also
referred to as “operating income,” operating profit serves as a good indicator of the
potential profitability of a business because it does not include all other external factors
from the calculation.

6. Taxes Due
Taxes basically refer to the total amount of tax debt owed by the business to the Bureau
of Internal Revenue (BIR), the taxing authority in the Philippines.

Tip
For corporations, the applicable income tax rate for both resident
and non-resident corporations is 30% based on their net taxable
income.

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Unit 12.2: Income Statement Preparation

7. Net Profit after Taxes

Net profit after taxes is the variable that always marks the end of an income statement. It
is a financial term that reflects the profit of a business after all taxes have already been
paid. It represents the earnings after all expenses have been deducted from the sales
revenue of the business.

Extend

Activity
Briefly explain the concept and purpose of an income statement. Limit your answer to five
sentences.

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Unit 12.2: Income Statement Preparation

Guide
● Define and explain in your own words what an income statement means.
● You must be able to state the different purposes of an income statement.

Evaluate

A. Answer the following questions briefly and coherently:

1. What is an income statement?

2. What is the relevance of an income statement in entrepreneurship?

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Unit 12.2: Income Statement Preparation

3. What is the main purpose of having an income statement?

4. What items are considered as direct expenses of a business?

5. How will you define the cost of goods sold (COGS)?

B. Read the situation below, then follow the given

instructions.

A startup manufacturing business produces various office and home furniture. Its products
range from computer desks, office tables, study tables, conference tables to dining tables.

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Unit 12.2: Income Statement Preparation

You were asked by the business owner to give suggestions or recommendations on how he
can prepare his business’s income statement. Provide suggestions on how he should
prepare an income statement.

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Unit 12.2: Income Statement Preparation

Wrap Up
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● An income statement, also known as the profit and loss statement, is a detailed
report that shows all the income or earnings, expenses, and the resulting profits or
losses of a business for a given accounting period.
● The formula for calculating the income or profit is: Revenues - Expenses = Income
or Profit (Loss)

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Unit 12.2: Income Statement Preparation

Bibliography
Burns, Paul. Entrepreneurship and Small Business: Start-up, Growth, and Maturity. Basingstoke:
Palgrave Macmillan, 2011.

Keister, Lisa A. Entrepreneurship. Boston: Elsevier JAI, 2005.

Mariotti, Steve, and Caroline Glackin. Entrepreneurship & Small Business Management. Boston:
Prentice Hall, 2011.

Piperopoulos, Panos G. Entrepreneurship, Innovation, and Business Clusters. Burlington, VT:

Gower, 2011.

Walzer, Norman. Entrepreneurship and Local Economic Development. Lanham: Lexington

Books, 2007.

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