How to Create a Projected Income Statement for Your Business: Cost Classifications and More

Starting or operating a business involves a lot of financial planning and management. A key component of this is creating a projected income statement for each month of the business, which requires a deep understanding of cost classifications and various cost concepts. This article will guide you through the process, detailing cost classifications and the steps needed to create an accurate projection. Additionally, we will discuss the importance of further education in finance and recommend useful resources for business owners.

Understanding Cost Classifications

When creating a projected income statement, it is crucial to classify costs correctly to achieve an accurate financial picture of your business. Here are the main categories of costs and how they are classified:

Direct Materials (DM)

Direct materials are the raw materials or components that go directly into the production of a product. For example, if you are in the manufacturing industry, your direct materials might include things like wood, metal, or fabric.

Direct Labour (DL)

Direct labour refers to the wages paid to employees who are directly involved in the production process. These workers are typically assembly line operators or other production staff who physically work on the product.

Direct Overheads (OH)

Direct overheads are costs that can be directly attributed to the production process. Examples include utilities, materials handling, and other indirect but essential costs for the production of goods.

Manufacturing Overheads (MOH)

Manufacturing overheads, or MOH, are indirect costs that cannot be directly traced to a specific product or job. These include indirect materials, indirect labour, and other manufacturing costs like rent, utilities, and maintenance.

Depreciation and Interest

Depreciation: This refers to the decrease in value of assets over time. It is typically included in manufacturing overheads. Interest Cost on Debts: These are the costs associated with loans and other debts the business might have incurred to finance its operations. Interest can significantly impact your financial statements and should be carefully accounted for.

Creating the Cost Sections in Your Income Statement

To create a projected income statement, begin by laying out the following sections:

Sales Revenue

The total revenue earned from sales during a specific period.

Cost of Sales (CoS)

Cost of sales includes the costs directly associated with producing the goods or services, such as direct materials, direct labour, and manufacturing overheads. Depreciation and interest costs, while important, are typically included in manufacturing overheads.

Sales Revenue - Cost of Sales Gross Profit

Indirect Costs

These costs include indirect wages, overheads, and other non-direct costs that contribute to running the business but cannot be directly linked to a specific product or job.

Gross Profit - Indirect Costs Net Profit

Additional Considerations and Education

A significant part of forecasting financial performance involves a thorough understanding of all these costs and the ability to accurately project them over time. This process can be complex and requires a solid foundation in accounting principles. If you or your management team are skeptical about your ability to handle this, it might be a sign that you are not ready to operate a business.

To improve your financial acumen, I recommend reaching out to the local university for an introductory course in accounting. Alternatively, purchasing textbook resources like Accounting I II and Managerial Accounting can provide you with the necessary tools and knowledge to manage your business's finances effectively.

Further Reading and Resources

For a comprehensive discussion on creating projected income statements, consider '60 Minute CFO: Bridging the Gap Between Business Owner, Banker, and CPA'. This Amazon bestseller offers valuable insights and practical solutions for business owners. Additionally, you can download the complimentary Business Mastery software, which is designed for financial statement analysis and forecasting. This can be particularly useful for understanding financial trends and making informed decisions.

Starting a business means taking on many responsibilities, one of which is managing the finances effectively. The key to success lies in proper planning, accurate cost classification, and continued education in business finance.