The income statement, one of the four principal financial statements, is a bit different for manufacturing and service companies. Generally accepted accounting principles give specific guidelines on the recording of transactions and the presentation of financial statements. It is important to know the specifics for your consulting firm in order to make sure that your financials are in order when talking with the bank.
The income statement for a consulting firm begins with consulting revenue. This is the revenue gained from the company's principal business, consulting. Generally accepted accounting principles state that revenue cannot be booked unless persuasive evidence of an agreement exists, services have been rendered, the price is fixed or determinable, and the ability to collect is reasonably assured. It is important to note under these rules other payments received, such as insurance proceeds or future payments are not considered revenue. Care must be exercised to determine that revenue recorded is in accordance with the generally accepted accounting principles.
Costs of Services
While manufacturing companies record a cost of goods sold, consulting companies do not have goods sold. However, costs of services, or costs of sales are an analogous account for service organizations. The consulting firm records all direct costs of providing services, such as wages for consultants, overhead for consulting offices, copying and research costs attributable to consulting engagements and constant fringe benefits to this account. General office overhead, executive costs and other costs not directly traceable to consulting engagements are excluded from this account. Finally, consulting revenue less costs of services gives us gross margin, the first subtotal on the consulting income statement.
The non-traceable costs of sales, general operations and administration are all considered operating expenses and form the next two or three headings on the income statement. While many companies break apart sales from general and administrative expenses, for non-publicly traded companies, presentation is flexible. For external financial statement users, operating expenses can be a focal point for consulting firms; the level of operating expenses relative to the company's sales sheds light on how frugal the company is and how lean the company could be if there was a drop in sales.
Net Income or Loss
Subtracting operating expenses from gross margin leaves net income or loss. In the first years of any business, breaking even or posting a profit is difficult. However, a consulting firm has the opportunity to grow slow, can often utilize a home office, and isn't usually capital intensive. As such, consulting firms are more likely to be profitable earlier in the company life cycle.
- "Principles of Financial Accounting"; Larson, et al; 2005