Getting Started

It’s much easier to think ahead for one year than it is for three. So, start with a one-year view. After putting together a reasonably thorough view of year one, it will be relatively easy to create years two and three by thinking of the changes that are expected to occur in the following years.

Notice how the income statement template is organized. Each column is labeled and represents a time period (usually a month) with totals for the year in the far right column.

Review from top to bottom the leftmost column of the sample income statement, to see all the categories of revenue and expenses, plus some subtotals for organization.

Income

Again, looking at the sample income statement, notice that a separate line is used for each major revenue category. The sample company includes lines for Programming Services, Software Sales and Network Maintenance. Think of the significant distinctions in your areas of revenue and create your own categories. Remember at this point to keep it simple. As you put together your income forecast, think carefully about the timing (when sales will begin) and growth rates you project. You will be asked if the business is ready to support the sales you are forecasting and whether you will have done in advance the necessary things to drive the level of sales you’re predicting in the time periods shown.

Cost of Goods Sold

Moving down the left column, look at the Cost of Goods Sold section, which is right below our Income categories. For companies selling products, the cost of the products being sold goes into this section. In our sample company, notice that in February they forecasted software income of $250, and there is a corresponding cost of goods sold of $150. This represents a product they purchase for $150 and resell for $250.

Some service businesses have costs associated with the services they sell. These would be treated in the same way, but would be called ‘costs of sales’ instead of costs of goods sold. Even sales commissions are sometimes included in the cost of sales category, both for product businesses and service businesses.

Whether it’s a cost of goods sold or cost of sales, this section should include outside expenses that are incurred whenever a sale takes place.

Gross Profit

Gross profit is completely different from the more common term “profit.” Gross profit is the total revenue, minus the cost of goods sold or the cost of sales. If your business sells furniture and you buy a desk for $300 and sell it for $500, your gross profit is $200. If you are a consultant and you invoice a customer for $500 and you have no cost of goods sold, your gross profit is the same as your sales ($500 sales minus $0 cost of sales = $500 gross profit).

The sample company sells mostly services, with some software sales. So their gross profit is quite high. Look, for example, at July and notice that they have $24,500 in total sales and cost of goods sold of $1,200. Why so low? Because the cost of goods sold is for software they purchase and resell. In July they had software sales of only $2,000. If we were to break it down further (this is not shown on the sample statement) they had software gross margin of $800 ($2,000 sales minus $1,200 cost of goods = $800 gross profit.)

Businesses that sell mostly products need to watch their gross profit carefully. What matters in this type of business is not how much you sell, but how much you keep—that’s gross profit.

Expenses

The expenses for the sample company are broken down into 14 categories. The major categories are self-explanatory (payroll expense, rent, etc.). When creating the list of expense categories for your business, keep it simple, using as few as 5 and no more than 20. It’s not critical whether you include the cost for small expenses in their own category, such as “office supplies,” or in a more general category such as “Office Expenses” (which would also include telephone, Internet and similar expenses).. The important thing is that all of your expenses are accounted for in one category or another.

Pay special attention to payroll costs, marketing costs and rent. These are likely to be your largest expenses. In your business plan you have probably addressed adding staff and marketing activities. Be sure that the income statement reflects the expense for these things in the time period when you said you were going to initiate the activity (or in advance, to allow for preparation time). Also make sure that your rent keeps pace with your payroll or headcount. You would expect to need more office space for 10 employees than for 3. There will be other corresponding expenses that grow with head count.

Look carefully at your revenue, payroll expense and overall expenses to be sure they are all moving in a logical pattern. If you study this carefully , you will get in tune with what it’s going to take to grow your business. You’ll soon find that you’re “living your business” on paper and able to make changes and decisions that will have a significant impact on your business. That’s what it’s about!

Net Ordinary Income. Net ordinary income is what is left when you subtract all of the expenses from all of the income:

Total Income – Cost of Goods Sold – Total Expenses = Net Ordinary Income

Since gross profit already subtracts the cost of goods sold from income, another way to calculate net ordinary income is:

Gross Profit – Total Expenses = Net Ordinary Income

So for year one in our sample company, the Total Income was $236,000, gross profit was $226,100, total expenses $204,597 and Net Ordinary Income was $21,503.

Wait a minute—isn’t that profit? Almost. If these become your actual numbers, your accountant will add a few more lines to take into account taxes, depreciation and a few of those other details we said were not critical for small-business-plan financial statements. For your business plan, rather than forecast profit, stop here at Net Ordinary Income.

Take your time to study our income statement template and get comfortable with it.  For additional perspective, you might want to review the Wikipedia article on income statements which is linked here.