Income Statement for Professional Service Companies

An income statement is a powerful tool that shows you how profitable your business is. It summarizes your revenues and expenses for a specific period, and reveals the net profit or loss at the end.

You may also hear it called a profit and loss account or a statement of operations.

However, not all income statements are the same.

Depending on your business needs and goals, you can choose from different types of income statements that present the information in different ways.

In this article, we will explain the different types of income statements and how they can help you manage your business functions and profits more efficiently.

By the end of this article, you will be able to create the perfect income statement for your business’s needs.

Income statement for service company

This example of the Profit and Loss account is based on the functions of the service company.

As such, it contains few profit levels. The profit levels shown in this income statement are:

• gross margin
• commercial margin
• EBITDA
• and net profit.

The file includes:

• Income statement with basic calculations
• All important components of the income statement
• Historical presentation through our 5 years (separate columns)
• Contribution to growth analysis
• Vertical analysis – ratio numbers
• KPIs calculation based on the Income statement

Components of income statements

An income statement is like a puzzle that shows you how your business is doing. The management decides how many pieces to include in the puzzle.

But there is a catch: if the puzzle has too many pieces, it can be hard to put it together and see the big picture. This is called analysis paralysis syndrome.

On the other hand, if the puzzle has too few pieces, it can be too vague and miss important details. This can lead to poor decision making and missed opportunities.

We shall explain the basic components below.

Revenues

Sale Revenues

These are the basic incomes – the ones you make by selling your services.

In some cases, the income statement only contains this item. However, if your business has multiple service lines, you can display each sales revenue per service line within the income statement.

Increasing the Value of Unfinished Services

Companies usually don’t calculate these revenues, which can affect the income statement’s accuracy.

Usually, you only record your services as income when you send the invoice to the customer. But what if your project takes several months to finish and you invoice at the end?

For example, you start a project in September and complete it in March of the next year.

You shouldn’t recognize all revenues within the following year (invoicing period). Instead, a part of the revenue should be recognized in the year in which expenditures were made for a specific project.

This is backed by the principle of causality in accounting.

The revenues in the current year should be recognized in the amount of the change in the cost price of the unfinished services.

Expenses

Cost of services (products) sold

These are the most direct costs you need for the production of a service, project, or product. Such costs are:

• Salaries
• Other expenditures to employees
• Bonuses
• Payment to subcontractors directly involved in the production of services
• Direct material costs
• Cost of goods sold (COGS – relevant for trading business only)

Direct costs

• Rentals
• Software use
• Staff education (this can be presented in the general cost as well)

Sales costs

Sales costs reflect the effort for selling your services.  Here are some examples to keep in mind:

• Marketing costs
• Networking costs
• Referral fees
• Sales costs
• Car costs for sales staff
• Other costs related to sales staff

General and Administration costs

• Insurance and Health
• Internet
• Courier, post office, phones
• Car costs (for general and admin staff)
• Office costs
• Donation and social responsibility costs

Depreciation

Depreciation is the process of measuring how much value fixed assets lose over time. Fixed assets are long-term assets that a business uses, such as buildings, equipment, or vehicles.

Depreciation helps a business set aside money to replace or repair fixed assets when they wear out or become obsolete. Depreciation also affects the selling price of the products or services that the business offers.

The basis for this calculation is the purchase value of the fixed asset.

For example, the cost of a piece of equipment is $5000, and its estimated useful life is 10 years.

The depreciation rate is 10% per year. So, the annual depreciation expense is $500.

Impairments

This cost is related to the loss of value of an asset.

Sometimes, you may not be able to collect the money that your customers owe you. When this happens, you need to reduce the value of your receivables and record the loss in your income statement.

Operating profit (EBIT)

The operating profit represents the difference between all operating incomes and operating expenses. It is the company’s income before interest and taxation.

EBITDA

EBIT and EBITDA are both ways to measure a company’s profitability. The difference is that EBITDA adds back the cost of amortization, a non-cash expense that reduces the value of intangible assets.

This means that EBITDA shows the company’s earnings before deducting depreciation, taxes, amortization, and interest.

Tax

The corporate tax represents the expenses coming from taxes. This expenditure depends on the corporate income tax rate applicable in the specific country. For example, this rate is 33% in some US states while it’s 19% in the UK.

Net profit

Net profit is the difference between total revenues and total expenses that have been reported in accordance with the generally accepted accounting principles for a certain period.

Net profit shows how efficient and profitable a business is, and it is also known as net income or the bottom line. Net profit must follow the rules and standards of accounting that are widely accepted and used by businesses.

How to prepare an income statement?

Technically, anyone can make an income statement if they have a basic understanding of calculations via tables (in Excel, for example).

The income statement preparation is based on accounting data.

If your accountant provides you with a trial balance or an accounting general ledger you can create an income statement fairly easily.

However, ensuring that the figures that form the basis for the preparation of the income statement are aligned with the generally accepted accounting standards (GAAP) is a challenge.

You will need some accounting knowledge for that.

Cost and profit centers

A good accounting system should let you assign a cost, profit, or organization center to each general ledger account. A general ledger account is a record of all transactions related to a specific type of account, such as cash, sales, or expenses.

A center is a way to group transactions by a certain criterion, such as a product, a department, or a location. If you set up a center to include only one item from the income statement, you can easily export the statement from the accounting software.

Statutory vs Management Income Statements

An income statement is a document that is usually submitted to the state authorities in all countries.

It lists the revenues, expenses, and net income or loss of the business. Most countries require businesses to submit an income statement to the government every year.

Some countries have a fixed format for the income statement that businesses must follow. This is called a statutory income statement.

However, businesses may also create their income statements for internal use. These income statements can have different formats depending on the needs and goals of the management.

They can show how well different parts of the business are performing and what factors affect the income and expenses of the business. These income statements are customized to the type of business and its activities. This is called a functional income statement.

Income statement analysis

Income Statement Vertical Analysis (variance analysis)

The income statement shows how much money a business makes or loses in a certain period. Vertical analysis is a way of comparing the income statements of different periods by using percentages.

Each line item on the income statement is shown as a percentage of sales or revenue. Then, you can see how much each item has increased or decreased from one period to another.

For example, you can have a column on the income statement that shows the percentage change of each item from the previous year. For example, the cost of salaries may have gone up by 14%.

But percentages are not enough. You also need to look at the actual amounts of money. Sometimes, a big percentage change may not mean a big difference in money. And sometimes, a small percentage change may mean a lot of money.

Income Statement Horizontal Analysis

Horizontal analysis is a way of comparing the financial statements of different periods to see how they change over time.

It helps you understand the trends and patterns of a company’s performance. It calculates the percentage change of each item from one period to another.

For example, you can use horizontal analysis to compare the net profit and sales revenue of a company for two years.

The net profit is the money that the company earns after paying all the expenses. The sales revenue is the money that the company makes from selling its products or services. You can divide the net profit by the sales revenue to get the net profit margin. This is a measure of how profitable the company is.

For example, if the net profit is $1,000 and the sales revenue is $100,000, the net profit margin is 1%. This means that for every dollar of sales, the company keeps 1 cent as profit. You can compare the net profit margin of different years to see if the company is becoming more or less profitable over time.

Some other examples of ratios in the horizontal analysis are:

• Share of wages in income
• Share of EBITDA in income
• Share of rentals in income

Analysis Concerning the Budget

As a rule, you should calculate the budget in the same form as your income statement.

If you have a monthly budget for every item in the income statement, you can see how far behind the budget you are at any time and take appropriate action.

Contribution to Growth Analysis

This analysis is utilized for performance monitoring. It is used on a specific service line or product group level.

Specifics of the income statements for different businesses

Here we list some specifics about the appearance of the income statement example, depending on the type of business

Law firm income statement

With law firms, it is important to monitor income in all branches of law.

Thus, the income statement should include income from, for example:

• Litigation
• Real Estate
• Banking and Finance
• Labor law
• Commercial Law

When it comes to expenses, it is most important to track the salaries.

The law firm’s gross margin is the amount of money left after paying the salaries of its employees. This is calculated by subtracting the salaries from the revenues. The gross margin shows how profitable the law firm is before considering other costs.

Some of the other costs that the law firm has to pay are rent, internet, and utilities. These costs are also part of the income statement.

The difference between revenues and salaries represents the law firm’s gross margin. Other expenses that should be included in the income statement are rent, internet and utility bills, etc.

If you have a functional income statement, you can track law firm metrics very efficiently.

Accounting firm income statement

In an accounting business, it is important to monitor revenues by service lines. These are, for example:

• Bookkeeping
• Payroll
• Tax advisory and compliance
• Financial reporting

The key expenses in the income statement are salary expenses, bonuses, software expenses, and rent. Marketing and sales costs are no less important.

Segmented income statement

A segmented income statement is a detailed version of the income statement that shows the profitability of different parts of the business, such as service lines.

This helps you understand how much money each segment contributes to the overall profit of the company (i.e organic profit).

You can segment the income statement by business units, service lines, or projects, depending on your needs. You can also track the income statement by employee, which shows you how much revenue and cost each employee generates. Hence, it can help you assess employee performances.

To create a segmented income statement, you need to allocate some general expenses and incomes to specific projects and employees. Time tracking tools are very efficient in tracking time per individual service line, and provide good directions for the allocation, i.e. creating a segmented income statement.

Income statement FAQ

Bojan Radojičić

Bojan Radojicic, Master Degree in Economics, is a financial performance consultant with more than 15 years of experience. He is responsible for adding value services based on innovative solutions.