There is an important difference when comparing the income statement for a service business, versus a business that sells finished goods. For the service business, there’s no inventory of raw material and or finished goods. Instead, the company must account for its “costs of sales,” whereas with the business that provides a finished good, there’s inventory and the company’s “cost of goods sold,” or COGS for short. One defines the costs of providing a service, while the other defines the costs of manufacturing, selling, or distributing a finished product. However, both the “costs of sales” and the “cost of goods sold” are used to determine a company’s gross profit. We’ll review how an income statement is put together for a service business by expanding on these aforementioned differences. At the end of this post is a sample excel sheet income statement for service businesses.
Understanding COGS and Cost of Sales
A company’s COGS include those costs that are directly attributed to the production or sale of a given product. These costs typically include the costs of labor, raw material, incoming and outgoing freight, and any additional costs that can be traced back to that product. Not included in the COGS are the company’s indirect expenses of salaries, taxes and other everyday expenses that are part of running a business, but that aren’t part of the production of the finished product.
A service company’s cost of sales is very similar to these aforementioned COGS. However, in the case of the service company, its cost of sales would include those costs that can be traced directly to providing a customer with a specific service. For instance, if you ran a consulting company, then your cost of sales would include the costs for those consultants who worked for a given customer, the costs to fly them out to the customer’s location, and any costs pertaining to hotel and accommodations. These are direct costs that are attributed to the job your company completed for this specific customer. Therefore, these are your cost of sales. Here are the calculations for gross profit and net profit when using cost of sales, as opposed to the COGS.
- Gross Profit = Sales – Cost of Sales
- Net Profit = Gross Profit – Total Expenses
Calculating Gross Profit
The calculation for gross profit is fairly straightforward. It simply involves taking the company’s sales and deducting the company’s cost of sales. In our example, the company’s sales for the month are $40,000.00 and its total cost of sales is $12,000.00. The entire gross profit calculation is defined below.
- Gross Profit = Sales – Cost of Sales
- Gross Profit = $40,000.00 - $12,000.00
- Gross Profit = $28,000.00
The Net Profit Calculation
A company’s net profit is its gross profit minus its indirect expenses. Calculating net profit simply involves taking the gross profit and deducting the company’s total indirect expenses. In our example, those indirect expenses are $17,750.00. The entire net profit calculation is defined below.
- Net Profit = Gross Profit – Total Expenses
- Net Profit = $28,000.00 - $17,750.00
- Net Profit = $10,250.00
The Income Statement for a Services Company
The first step of the sample excel sheet income statement includes defining the period of the income statement. Our income statement is a representation of the company’s activities for the month of January. The second step includes providing the sales for the month. The third step includes defining what is included in the company’s costs of sales. In our example, these costs include the time charged for the company’s consultants, the costs of the hotel, the rental car costs, the costs for food and the costs of plane tickets. The fourth step is to add up all these direct costs and provide a total for the company’s total costs of sales. The fifth step includes defining the company’s gross profit. Again, the gross profit calculation is simply the company’s sales minus its cost of sales. The sixth step includes itemizing the company’s indirect expenses.
Remember, these are expenses that are not directly attributed to any particular job or service, but that are essential to running the consulting business. These indirect expenses include the company’s expenditures on its marketing strategies, its salaries for its stales team, insurance for its office and employees, the costs to rent office space, the costs of electricity, the costs for an administration professional and any miscellaneous costs relating to office equipment. The seventh step includes itemizing all of these expenses, while the eighth and final step includes determining the net profit.
Remember, the income statement can be used to track the service business's financial performance for a given, month, quarter or year.
It is an essential tool when looking to define the company’s sales, its direct costs, its indirect costs, in addition to its gross profit and net profit.
Again, the main difference is that the service business calls upon the cost of sales, rather than the cost of goods sold. This sample excel sheet income statement is based on a simple premise of capturing all eight aforementioned points.
That sample sheet is included here: Download Sample income statement for small services company
If you are looking for insight into how you can determine your service business's hourly rate, then please refer to the following video. It is from the post: Determining Hourly Rates for a Contractor or Small Business
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