9.2: Income Statement

Income Statement

An income statement or profit and loss account (also referred to as a profit and loss statement (P&L), statement of profit or loss, revenue statement, statement of financial performance, earnings statement, operating statement, or statement of operations) is one of the financial statements of a company and shows the company’s revenue and expenses during a particular period. It indicates how the revenues (money received from the sale of products and services before removing expenses, also known as the “top line”) are transformed into the net income (the result after all revenues and expenses have been accounted for, also known as “net profit” or the “bottom line”). It displays the revenues recognized for a specific period, and the cost and expenses charged against these revenues, including write offs (e.g., depreciation and amortization of various assets) and taxes. In sum, the oncome state is measure of revenue and expenses to arrive at a profit or loss figure. It is nothing more than:

Revenue – Expenses = Net Profit/Loss

The purpose of the income statement is to show managers and investors whether the company made or lost money during the period of the report. One important thing to remember about an income statement is that it represents a ‘period of time’. This contrasts with the balance sheet, which represents a ‘single moment in time’.

The income statement can be prepared in one of two methods.

1. The Single Step income statement takes the simpler approach, totaling revenues (income) and subtracting expenses (expenses) to find the bottom line (profit).
2. The more complex Multi-Step income statement (as the name implies) takes several steps to find the bottom line, starting with the gross profit. It then calculates operating expenses and, when deducted from the gross profit, yields income from operations. Adding to income from operations is the difference of other revenues and other expenses. When combined with income from operations, this yields income before taxes. The final step is to deduct taxes, which finally produces the net income for the period measured.

Usefulness and limitations of income statement

Income statements should help investors and creditors determine the past financial performance of the enterprise, predict future performance, and assess the capability of generating future cash flows through report of the income and expenses.

However, information on an income statement has several limitations:

• They do not report items that might be relevant but not reliably measured (e.g., brand recognition and loyalty)
• They do not report some numbers depending on accounting methods used (e.g., using FIFO or LIFO accounting to measure inventory level).
• They do not report some numbers that depend on judgments and estimates (e.g., depreciation expense depends on estimated useful life and salvage value).

Guidelines for statements of ‘comprehensive income’ and ‘income statements of business entities’ are formulated by the International Accounting Standards Board (FASB). Names and usage of different accounts in the income statement depend on the type of organization, industry practices and the requirements of different jurisdictions. If applicable to the business, summary values for the following items should be included in the income statement:

Operating section

Revenue

Cash inflows or other enhancements of assets (including accounts receivable) of an entity during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major operations. Every time a business sells a product or performs a service, it obtains revenue referred to as gross revenue or sales revenue. An operation would generally equate revenue to be sales minus sales discounts, returns, and allowances. This is an important calculation because revenue is taxable by federal state, and local governments. An operation should pay tax on the revenue it actually receives.

Revenue = sales minus discounts, returns, and allowances

Expenses

Cash outflows or other using-up of assets or incurrence of liabilities including accounts payable during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major operations.

Cost of Goods Sold (COGS) / Cost of Sales - represents the direct costs attributable to goods produced and sold by a business (manufacturing or merchandizing). It includes:

• material costs,
• direct labor
• overhead costs
• excludes operating costs (period costs) such as selling, administrative, advertising or R&D, etc.
• Selling, General and Administrative expenses (SG&A or SGA) - consist of the combined payroll costs. SGA is a major portion of non-production related costs, in contrast to production costs such as direct labor.
  • Selling expenses - represent expenses needed to sell products (e.g., salaries of sales people, commissions and travel expenses, advertising, freight, shipping, depreciation of sales store buildings and equipment, etc.).
  • General and Administrative (G&A) expenses - represent expenses to manage the business (salaries of officers / executives, legal and professional fees, utilities, insurance, depreciation of office building and equipment, office rents, office supplies, etc.).
• Depreciation / Amortization - the charge with respect to fixed assets / intangible assets capitalized on the balance sheet for a specific (accounting) period. It is a systematic and rational allocation of cost rather than the recognition of market value decrement.
• Research & Development (R&D) expenses - represent expenses included in research and development.

Expenses recognized in the income statement should undergo analysis either by nature (raw materials, transport costs, staffing costs, depreciation, employee benefit etc.) or by function (cost of sales, selling, administrative, etc.). If an entity categorizes by function, then additional information on the nature of expenses, at least, – depreciation, amortization and employee benefits expense – need disclosure. The major exclusive of costs of goods sold, are ‘operating expenses’ by classification. These represent the resources expended, except for inventory purchases, in generating the revenue for the period. Expenses generally fall into two broad sub classifications selling expenses and administrative expenses.

Non-operating section

• Other revenues or gains - revenues and gains from other than primary business activities such as: rent, income from patents, goodwill). It also includes unusual gains that are either unusual or infrequent, but not both (gain from sale of securities or gain from disposal of fixed assets)
• Other expenses or losses - expenses or losses not related to primary business operations, (e.g., foreign exchange loss).
• Finance costs - costs of borrowing from various creditors (interest expenses, bank charges).
• Income tax expense - sum of the amount of tax payable to tax authorities in the current reporting period (current tax liabilities/ tax payable) and the amount of deferred tax liabilities or assets.

Example

The following is a basic profit and loss projection for a three-year period. The purpose of the three-year projection is to allow a visualization of where sales and profits may be - given a small percentage change in revenue. A change in revenue will not affect fixed charges and will generally only affect ‘prime’ costs such as food and beverages. Thus, a ten percent increase in sales will influence profit substantially. The percentages to the right of the numbers indicate the percentage of gross profit the expense item represents. For example, an inventory expense of $75,000 represents a 39.3% cost based on gross sales. Thus, it is important to know not only your costs but also the percentage of gross revenue they represent. This knowledge helps you to adjust costs appropriately to increase profitability. Marketing represents 26.2% of gross revenue in the example. While this may seem high, if you are new and unknown, this figure may be low in comparison to your marketing need. The location of the restaurant will greatly affect marketing costs. Therefore, the numbers are relevant to your operation and are generally ‘location’ specific.

Allon's Manger Three Year Profit Projection Sensitivity Analysis
	Projected Sales		110% of Sales		120% of Sales
Food Sales	2,000,000		2,200,000		2,400,000
Beverage Sales	200,000		220,000		240,000
Gross Profit	2,200,000		2,420,000		2,640,000
Sales Tax	176,000
Gross Profit After Tax	2,040,000
Operating Expenses
Accounting and Legal	5,000	0.2%	5,000	0.2%	5,000	0.2%
Advertising	50,000	2.3%	50,000	2.1%	50,000	1.9%
Depreciation	10,146	0.5%	10,146	0.4%	10,146	0.4%
Employee Benefits	15,000	0.7%	16,500	0.7%	18,000	0.7%
Insurance	25,000	1.1%	25,000	1.0%	25,000	0.9%
Interest	132,000	6.0%	145,200	6.0%	158,400	6.0%
Inventory (food)	607,200	30.0%	774,400	32.0%	844,800	32.0%
Inventory (Beverage)	364,320	18.0%	435,600	18.0%	475,200	18.0%
Labor (Variable)	647,680	32.0%	647,680	26.8%	647,680	24.5%
Music and Entertainment	2,400	0.1%	5,400	0.2%	5,400	0.2%
Rent	24,000	1.1%	24,000	1.0%	24,000	0.9%
Repairs & Maintenance	8,000	0.4%	9,000	0.4%	9,000	0.3%
Replacement (china & glass)	3,000	0.1%	3,000	0.1%	3,000	0.1%
Supplies	36,000	1.6%	39,600	1.6%	43,200	1.6%
Utilities	13,800	0.6%	15,180	0.6%	16,560	0.6%
Taxes (Sales and Use)	176,000	8.0%	193,600	8.0%	211,200	8.0%
Other Expenses
Total Expenses	2,119,546		2,344,306		2,491,586
Net Profit Before Tax	120,311		153,611		186,911
Income Taxes
Net Profit After Tax

This is another example of a profit and loss statement in a move expansive form. This example indicates a clearer picture of ‘where’ revenue is occurring. Note that food sales could also be indicative of the ‘source’ of the sales such as dining, takeout, catering, delivery, proprietary food products for sale, and so forth. In and of itself, the profit and loss statement, to refresh, is nothing more than revenue minus expenses to arrive at a profit or a loss. The restauranteur has the freedom to expand the inclusions in any category to better explore a revenue or expense element. The depth of the income statement speaks to ‘decision power’ the statement can afford to the operator.

Sample P & L
Category	Annual Budget $	% of Sales
Income
Food Sales	$975,000	65.00%
Beverage Sales
Liquor Sales	$183,750	35.00%
Wine Sales	$262,500	50.00%
Beer Sales	$52,500	10.00%
NA Bev Sales	$26,250	5.00%
Total Beverage	$525,000	35.00%
Sales Adjustment	$1,050	0.07%
TOTAL SALES	$1,500,000	100.00%
TOTAL INCOME	$1,498,950	99.93%
Cost of Goods Sold
Food Cost	$292,500	30.00%
Beverage Cost
Liquor Sales	$27,563	15.00%
Wine Sales	$78,750	30.00%
Beer Sales	$8,925	17.00%
NA Bev Sales	$5,250	20.00%
Total Beverage Sales	$120,488	23.00%
Labor Cost
FOH	$209,853	14.00%
BOH	$254,822	17.00%
Other Costs
Health Insurance	$10,500	0.70%
Worker's Compensation	$12,741	0.85%
Payroll Taxes	$82,442	5.50%
Payroll Fees	$17,987	1.20%
Total Other Costs	$123,671	8.00%
Total Labor Cost	$614,570	41.00%
TOTAL COST OF GOODS SOLD	$1,027,557	69.00%
GROSS PROFIT	$471,393	31.00%
Expenses
Operating Expenses
Restaurant Supplies	$9,743.18	0.65%
Kitchen Supplies	$11,991.60	0.80%
Decor	$3,747.38	0.25%
Tabletop	$8,993.70	0.60%
Uniforms	$2,248.43	0.15%
Laundry and Linen	$8,993.70	0.60%
Cleaning Supplies	$5,995.80	0.40%
Credit Card Fees	$52,463.25	3.50%
Gift Card Expenses	$899.37	0.06%
Reservation System	$5,246.33	0.35%
Music	$749.48	0.05%
Security	-	0.00%
Printing	$4,496.85	0.30%
Sales Tax	$2,248.43	0.15%
Total Operating Expenses	$117,817	8.00%
Occupancy Expense
Rent	$37,474	2.05%
Insurance	$2,548	0.17%
Utilities	$19,486	1.30%
Repairs and Maintenance	$4,497	0.30%
Total Occupancy Expense	$64,005	4.27%
General and Administrative
Marketing and Advertising	$37,474	2.50%
Research and Development	$1,049	0.07%
Legal Fees	$8,244	0.55%
IT Fees	$4,497	0.30%
Bookkeeping	$17,987	1.20%
Accounting	$11,992	0.80%
Licenses and Permits	$5,996	0.40%
Office Supplies	$3,747	0.25%
POS System	$2,248	0.15%
Computer Supplies	$2,248	0.15%
Bank Fees	$1,499	0.10%
Employee Appreciation	$749	0.05%
Total General/Administrative	$97,732	7.00%
TOTAL EXPENSE	$279,554	19.00%
NEW OPERATING INCOME	$191,839	13.00%

The following table represents restaurant industry ‘dollar’ percentages for sales and expenses one may incur in a restaurant operation. You can apply these percentages for each item to arrive at a reasonable amount of expense for that item based on the gross revenue you project for your initial year’s sales. These percentages will help you to calculate your ‘projected income statement’ for a lender.

The Restaurant Industry Dollar
	Full Service Restaurants (Average check per person under $10)	Full Service Restaurants (Average check per person $10 and over)	Limited Service Fast Food Restaurants
Where it came from	As a Percentage of Total Sales
Food Sales	89.6	78	95.7
Beverage Sales (alcoholic)	10.4	24	4.3
Where It Went	As a Percentage of Total Sales
Cost of Goods Sold	32.2	30.0	28.4
Cost of Beverage Sold	3.2	7.8	1.2
Salaries and Wages	28.0	28.9	24.2
Employee Benefits	3.9	4.2	3.7
Direct Operating Expenses	7.0	6.5	6.7
Music and Entertainment	0.2	0.9	0.1
Marketing	2.3	2.5	5.7
Utility Services	3.2	2.3	2.8
Restaurant Occupancy Cost	5.2	5.3	7.4
Repairs and Maintenance	1.7	1.6	2.0
Depreciation	2.3	1.8	3.1
Other Operating Expenses (income)	0.3	0.2	0.4
General and Administrative	3.2	4.2	3.7
Corporate Overhead	2.7	1.4	8.8
Interest Payments	0.8	0.8	0.8
Other Expenses	0.2	0.3	0.3
Income before Income Tax	3.8	3.5	9.5

* All figures are weighted averages
* All amounts are reflected as a percentage of total sales