Seven (7) Ways Businesses Spend Money Before Making Real Profits

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Understanding the Income Statement is important if you are a manufacturer, wholesaler, retailer, or if you are engaged in any business that makes, buy, or sells goods to earn income. But even though most business owners tend to entirely leave the aspect of financial accounting to professional accountants, there’s a valuable knowledge found on the Income Statement that can help businesses to learn, compare, improve, and control cash flow on all stages of the overall organizational operations. 

In this post, I have presented this to appear as simple as it can be, because the subject of financial accounting is something a lot of folks are not very familiar or keen with. So, if you’re one of those I just described, the following are some of the items you’ll find, if you take a look at the Income Statement of any company: (1) Sales Revenues (2) Cost of Sales (3) Gross Profit (4) Other Operating Income (5) General and Administrative Expenses (6) Distribution Costs (7) Depreciation (8) Interest Expense (9) Taxation (10) Retained Profit  

Here’s how a typical Income Statement looks like in presentation.

The items highlighted are what we’ll be looking at in this post. These are yearly expenses that businesses take on, going from year to year, while still remaining well-focused, and maintaining a profitable status. The Sales Revenue is the most important item on the Income Statement. It is a measure of the sum total of cash flow into the business as a result of sales of products and/or services, during a specific period of time

Cost of Goods Sold 

Cost of Goods Sold Cost of Goods Sold (COGS) are the direct costs attributable to the production of the goods sold by a company. It is usually the largest expenses on the Income Statement of a company selling products or goods.

The Cost of Goods Sold is calculated as the accumulated total of all costs used to create a product or service, which has been sold. This amount includes the cost of the materials used in creating the goods along with the direct labour cost, and overheads, used to produce the goods. In a retail or wholesale business, the Cost of Goods Sold is likely to be the merchandise that was bought from a manufacturer. In the Income Statement presentation, the Cost of Goods Sold is usually subtracted from the Sales Revenue (Turnover) to arrive at the Gross Margin of a business. 

Cost of generating Other Operating Income

As a company, it is possible to indulge also in other forms of businesses that are not directly related to the main line of business activity that the company is established for.

So, in addition to the Sales Revenue (Turnover) from selling products and/or services, businesses may realize income from other sources, and by so doing are able to earn extra income. These activities are usually classified under the non-operating items section, as it is not tied directly to the regular organization operation. For example, a business may have earnings from investments in one or more marketable securities, or having shares of other companies. In other instances, a company can decide to buy and hold property in the form of real estate. However, in the income statement, the income from these investments goes on a separate line and isn’t commingled with Sales Revenue. 

General and Administrative Expenses 

These are the costs that are required to keep the business running efficiently. In the company’s Income Statement, these expenses generally appear under operating expenses. It encompasses a variety of expenses associated with performing the daily operations in a company. 

General and Administrative Expenses pertain only to operational expenses, and does not include expenses that can be directly related to the production of any goods or services. To be more specific, the following are typical examples of costs classified under the General and Administrative Expenses of a company: 

•  Rent 
•  Utilities 
•  Managerial/Staff salaries 
•  Legal 
•  Insurance 
•  Other professional expenses (research & development)  

Distribution Cost 

After goods are produced, they are usually moved from the store house of the manufacturers and transported to the marketplace where it exchange hands with users for cash in return. In most cases, these goods are shipped long distances across the ocean to get into the hands of people who need it. 

The distribution cost is therefore the total amount of cost or expenses incurred in moving goods and/or services from the point of production to the point of consumption. It is also referred to as the distribution expense. But for businesses offering digital services, the leverage of the internet helps to cut down any cost of transport across the world, assuming that there is a reliable computer and internet connection to meet the customer’s needs.

 Interest Expense 

Interest Expense are non-operating expenses shown on the Income Statement. It represents the total amount of interest payable on any type of borrowings which include bonds, loans, convertible debt or lines of credit. It is basically calculated as the interest rate multiplied by the outstanding principal amount of the debt. 

 A major advantage that companies will always have over the ordinary person, is the fact that the former can confidently obtain money to run part of their operation by borrowing, and the resulting interest expense payable on the money, even if it runs into tens of thousands of Dollars, are tax-deductible, going by the accounting principles of preparing the Income Statement. 

The Interest Expense on the Income Statement represents only the interest accrued during the period covered by the financial statements, and not the amount of interest that was paid over the period in consideration.

Taxation 

Taxation is a means by which governments in every country finance their expenditures by imposing monetary charges on citizens and corporate entities. To be able to get specific information, check the details of the tax laws and corporate laws of any country. 

All businesses must file a return annually, and will therefore proceed and start transferring the money to their country’s government. Not paying the complete amount of tax to the government is a capital offence in the court of law.

Proposed Dividend 

Dividends are one of the legal rights of a shareholder of any corporate company. And prompt payment of dividends by companies turn their shareholders into happy and loyal customers. It is a way in which a company shares its profit to its shareholders. Each shareholder gets an amount depending upon the number of shares they has. 

In the Income Statement, the amount of money remaining after the dividend have been paid out to the shareholders, is then transferred to the general reserve. A simple typical example of an income statement of a certain company XYZ, in dollars, is presented in the table below, for the year ending 31st December, 2011: 

Taking a closer look at the income statement you can notice how all these seven (7) categories of expenses are subtracted accordingly from the top, directly from the Sales Revenue (Turnover). This is done according to the laws of financial accounting. This important feature continues to differentiate the worker from the employers of registered companies. Because the income taxes are first deducted before the former gets his/her paycheck, while the government tax only a certain portion of the latter’s Revenue (referred to as taxable income); after the sum of all business expenses have been deducted. 

Let’s take a quick look again at those seven (7) expenses: (1) Cost of Sales; (2) Cost of generating other Operating Income; (3) General and Administrative Expenses; (4) Distribution Cost; (5) Interest Expenses; (6) Interest Expenses; (7) Dividend paid 

The reason entrepreneurs love being entrepreneurs, is because they are willing to make these seven (7) categories of spending before making real profit. The corporate law and even the tax laws are on their side. Companies are legally allowed to keep the total amount of money needed for next year’s expenses. That simply means that they’re only taxed after spending, unlike an individual who is taxed before he/she will spend.

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