Understanding Business Accounting For Dummies, 2nd Edition (39 page)

Income tax expense:
Income taxes paid by the business,
not
including property and employer payroll taxes, which are included in the sales, administrative, and general expenses line. Income tax expense is always reported on a separate line. The final profit line, the bottom line after you deduct income tax, is called
net income
- the bottom-line profit figure, unless the business has extraordinary gains and losses to report. If so, the non-recurring gains and losses are included to get down to the bottom line.

To close the business example that we've been using throughout this chapter, here is your annual profit and loss account:

Annual Profit and Loss Account for the Example

Sales revenue +1,000,000

Cost of goods sold expense -
600,000

Gross margin +400,000

Sales, administrative, and general expenses -
285,000

Earnings before interest and tax (EBIT) +115,000

Interest expense -
25,000

Earnings before income tax +90,000

Income tax expense -
30,000

Net income
+60,000

H
ere are two key points to keep in mind about profit and loss accounts:

The profit and loss account format that we discuss here is what you find in
external
reports released outside the business that are directed to its absentee owners who do not participate in the day-to-day management of the business. The external profit and loss account does not provide the level of detail about sales revenue and expenses needed for management purposes. Managers must have reports that drill down to the relevant detail they need to make specific decisions and for control purposes. The external profit and loss account is a fairly condensed summary.

The profit and loss account does not report the financial effects of sales revenue and expenses - the increases and decreases in the assets and operating liabilities that revenue and expenses cause. Readers of the profit report have to look at the balance sheet to see the assets and liabilities of the business. Actually, the cash flow statement that Chapter 7 explainsis the link between the profit and loss account and the balance sheet. In short, the profit and loss account is not really a stand-alone financial statement; you have to put it into the financial context of the business's other two primary financial statements: the balance sheet and the cash flow statement.

The
www.score.org
Web site offers a downloadable Excel spreadsheet that enables you to tailor a profit and loss account to your own needs. Scope exists for seven categories of revenue, seven cost of sales categories, and 20 items of expense. You can find the spreadsheet by going to the SCORE homepage and clicking on ‘Business Tools', ‘Template Gallery', and finally on ‘Profit and Loss Projections'.

Reporting unusual gains and losses

The road to profit is anything but smooth and straight. Every business experiences an occasional
discontinuity
- a serious disruption that comes out of the blue, doesn't happen regularly or often, and can dramatically affect bottom-line profit. In other words, a discontinuity is something that disturbs the basic continuity of business operations - the regular flow of profit-making activities.

Here are some examples of discontinuities:

Downsizing and restructuring the business

Abandoning product lines

Settling lawsuits and other legal actions