To properly understand a company’s income statement there are a variety of factors that plays a major role. If calculated properly you will be able to identify the gross profit of the company along with its net income. To start the income statement you will need to identify the amount of revenue (sales) that the company has made thus far in a given time period. Sales/revenue is considered to be the amount of cash/credit (basically money) that a company generates in a given period including discounts with consideration of returned merchandise. After identifying the revenue the next step is to calculate the cost of goods sold (COGS).
This can be found through multiple ways, it depends on how you want to make the numbers look for an investor. The first of which is the First in first out method (FIFO), this method gives a lower result for net income and less in taxes. The first in first out measures the ending inventory. The next method is the Last in First out (LIFO), which measure the beginning inventory. This calculation produces a more favorable result for net income, but results in higher taxes being paid. The last method is to do a summation, pretty much an average of all your remaining inventories and cost of those inventory and find an average price. By using the average method net income will mid-way between your FIFO and LIFO results, same goes with the tax associated. When you have calculated COGS then you will be able to get the company’s gross profit by using the following formula [revenue-COGS] =gross profit.
It is very important to understand that gross profit is not your final income. What I mean by that is that gross profit is the amount of money you have on hand before you pay your bills. Bills/operating expense are generated from things such as storage space rental, insurance, equipment purchases, etc. Operating expenses are sometimes easy to identify by finding the accounts payable journal entries. After you have added up all your expenses from accounts payable then you are now capable of generating the Income before tax figures. The income before tax is calculated by using the following method [gross profit-operation expense].
Subsequent to recognizing what your income before tax is then you can proceed with calculating the amount of tax to be withheld. Depending on the state you are in and sometimes the type of business you are in the tax percentage will be different. Therefore, it is best to have a license accountant consult your business to ensure that you are paying the right amount in taxes and also to see where you can save a few dollars in operation cost. OK, so once you have the tax percentage calculated for your business type and state then you minus the percentage amount in dollars, (for example 10% of $10.00 is $1.00, 10-1=9),then you subtract the tax amount from your income before tax [income before tax-tax expense]. This will produce the net income for the business. There you have it, understanding the income statement line by line. Until next time think ethically.