Understanding the Projected Income Statement

The projected income statement shows a company's profitability. It reports on the making and selling activities of a business over a predetermined period of time: typically a month, quarter, or year.

Sales – (Costs + Expenses) = Income

Let's start with sales. You record sales on the income statement when product is shipped or a service is performed. It is important to note that sales do not occur when the product is ordered or the service is scheduled. The sales figure used is the net sales figure; in other words, the true price paid when discounts are applied.

You may be asking yourself why orders aren't included in the sales figure: Orders create a backlog, but they don't generate income until they become a sale. Receiving an order does not guarantee a sale.

Only once you ship the product or perform the service is there a sale. Until that time, it's simply an order — a product order or a service order. Accountants often refer to sales as revenue.

Costs, in comparison, are expenditures. They can include materials, wages, contractor fees, and general overhead.

Basically, costs are what you spend either to buy or make an item or to perform a service. With physical products, this figure is taken out of inventory and entered into the income statement as an expense and is termed cost of goods sold.

This can be a bit confusing. The basic rule is that costs lower cash values while increasing inventory on the balance sheet. The total value remains the same, but the distribution of goods is altered.

When inventory is sold, its value moves from the balance sheet to the income statement. In other words, a potential sale has become a true sale. Product in inventory was shipped to the customer.

At this point, let's clarify two terms that can sometimes be confusing and unknowingly interchanged: cost and expense. Both differ from expenditure.

Costs are manufacturing expenditures. What is needed to build up your inventory falls under this category.

Expenses are everything else. They can include the general and administrative areas of your business: everything from the copy machine to the salesperson's mileage, and his or her salary or commission. Consultations with your accountant are expenses, for example.

Expenses impact the income statement because they lower the income tally. Both costs and expenses are expenditures.

Not to confuse matters more, there is a special category of expenses known as operating expenses. These are the expenses that a company experiences while trying to generate an income and can include sales and marketing, research and development, and general and administrative expenses. You may find them listed on the sample financial sheets as SG&A expenses, representing sales, general, and administrative expenses.

And now we get to the bottom line of the equation — income.

Income occurs when the sales total exceeds costs and expenses. Now, you've made a profit! This is every business's goal.

Up until the point where you make a profit, you'll experience a loss.

Income can also be referred to as profit or earnings. And for that reason, the income statement itself can be called the profit and loss statement or P&L or earnings statement.

There are two ways to handle a company's books or records — cash basis or accrual basis.

In a cash-based system, income is measured when cash is actually received and expenses are measured when cash is actually spent. It's a real-time scenario.

In comparison, an accrual-based system occurs when an accounting system is based on when the transaction itself takes place and not on when the cash physically exchanges hands.

Most companies use a cash system. In a cash-based system, the income statement and the cash flow statement are the same.

Carol Parenzan Smalley is an educator, innovator, and entrepreneur. She is the creator of and instructor for Creating a Successful Business Plan, an online course offered by colleges and universities around the world.