Accounting – Self Study Guide for Staff of Micro Finance Institutions

LESSON 3
The Income Statement

OBJECTIVES The purpose of this lesson is to introduce the Income Statement and to
define revenue and expenses. The relationship between revenue and
expenses and their affect on the Income Statement will be explained.

You will become familiar with definitions of items commonly seen on the
Income Statement and how the Income Statement is created. You will
develop an understanding of how the Income Statement reflects transactions
for a specified period of time rather than at a specific “point-in-time”.
Topics include:
• The Income Statement
• Revenue
• Expenses
• Comparative Income Statement

The Income Statement

The Income Statement summarizes all income earned and expenses incurred
during a specified accounting period, and shows the net income (or net
loss) earned over that period. Unlike the Balance Sheet which reflects a
static position at a “point-in-time”, the Income Statement reflects all
transactions which have occurred during the “accounting period”. The term
“accounting period” simply refers to the period of time covered by the
Income Statement. The accounting period is set to best suit the needs of
managers of the organization and may vary between organizations.
Generally, the accounting period refers to one fiscal year or one month.

To determine net income, an organization must measure:

i. the revenue received (or accrued) for goods and services provided to its
clients, and

ii. the cost of goods and services which it incurred in a specified time
period.

The technical accounting terms for these elements of net income are
revenues and expenses. Net Income is the difference between revenue and
expenses.

Net Income = Revenues – Expenses

Refer to the Sample Income Statement on the next page.

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SAMPLE INCOME STATEMENT

ABC Credit Programme

STATEMENT OF INCOME AND EXPENDITURE
For the period ended December 31, 1995
FINANCIAL INCOME:
Interest on Current & Past Due Loans 15,400
Interest on Restructured Loans 100
Interest on Investments 500
Loan Fees/Service Charges 5,300
Late fees on Loans 200
Total Financial Income 21,500
FINANCIAL COSTS:
Interest on Debt 3,700
Interest paid on Deposits 0
Total Financial Costs 3,700

GROSS FINANCIAL MARGIN 17,800

Provision for Loan Losses 2,500
NET FINANCIAL MARGIN 15,300
Operating Expenses
Salaries and benefits 6,000
Administrative expenses 2,600
Occupancy expense 2,500
Travel 2,500
Depreciation 400
Other 300
Total Operating Expenses 14,300

NET INCOME FROM OPERATIONS 1,000

Grant Revenue for Operations 0
Excess Of Income Over Expenses 1,000
Source: SEEP Financial Services Working Group

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Revenue

In accounting terms, revenue refers to money received (or to be received)

by the organization for goods sold and services rendered during a given
accounting period. When an organization renders services or sells
merchandise to its clients, it usually receives revenue in the form of cash or
an account receivable. Revenue for a micro-finance organization includes:
interest earned on loans to clients; fees earned on loans to clients; interest
earned on funds on deposit with a bank, etc.

Expenses

Expenses represent the costs incurred for goods and services used in the
process of earning revenue. They are often referred to as the ‘cost of doing
business’ since they represent the costs that are necessary for the
organization to generate revenue and thus remain in operation. Direct
expenses for a micro-finance organization include financial costs, operating
expenses and loan loss provisions (a fourth cost - the Imputed Cost of Capital
- is discussed in the FINANCE study guide).

Accounting Definitions (Income Statement)

⇒ Financial Income:

• Interest on Current and Past-Due Loans - the amount collected

from clients for borrowing money from the organization for a
specified period of time. The interest rate is generally stated as a
percentage of the loan amount on an annual or period basis.
[Note: the principal amount of the loan repaid is not included in
income. Only the Balance Sheet accounts are affected by the
principal portion of the loan repayment, i.e. the Loans Outstanding
decrease and Cash increases. The only time the Income Statement is
affected by the principal portion of a loan is when a loan which has
been written off is repaid. This is discussed further in the FINANCE
study guide.]

• Interest on Restructured Loans - the amount of interest collected

from borrowers on loans which have been restructured.

• Interest on Investments - the amount of interest earned by the

organization on its investments such as term deposits and treasury
bills.

• Loan Fees/Service Charges - the amount collected from borrowers

or members, stated either as a percentage of the loan amount or as a
flat fee, for loans disbursed.

• Late Fees on Loans - the amount collected, as a penalty, from

borrowers who have had loans with payments in arrears.

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⇒ Financial Costs
• Interest on Debt - interest paid by the organization to banks and
other financial institutions for money loaned to the organization.
[Note: the repayment of the principal portion of a bank loan is not
included as a financial cost. It is a reduction of a liability on the
Balance Sheet.]

• Interest Paid on Deposits - interest paid to clients who deposit

savings in the organization (either voluntary or forced).

⇒ Provision for Loan Losses - based on the historical default rate and the
current outstanding Loan Loss Reserve, the Provision for Loan Losses is
the amount expensed in a period to increase the Loan Loss Reserve to an
adequate level to cover expected defaults of the loan portfolio.
Although the Provision for Loan Losses is a non-cash expense, it is
treated as a direct expense for a micro-finance organization even though
loans will not yet have been written off as loan losses. Some
organizations include the Provision for Loan Losses with the operating
costs. It is helpful to separate the Provision for Loan Losses as a
separate cost as an indicator of portfolio quality. (See Loan Loss Reserve
on the Balance Sheet.)

⇒ Net Financial Margin - the margin between the revenue an organization

generates by lending and the financial costs associated with funding the
loan portfolio.

⇒ Operating Expenses - expenses which are specific to delivery of credit

and savings activities for a specified time period. For a single-purpose
organization, all costs should be included. For multi-purpose
institutions, all direct costs of financial operations and an appropriate
portion of the institution’s overhead should be included. The main
categories of operating expenses are:

• Salaries and benefits - payments to staff for services rendered.

• Administrative expenses - costs incurred for administering the

organization such as stationery, insurance, legal fees, etc.

• Occupancy expenses - expenses made for (i) lease of land and/or

buildings for the credit activities, and (ii) expenses for utilities, such
as electricity, water, and telephone.

• Travel - expenses for transportation, room and board, etc., of staff

members traveling for the organization.

• Depreciation - an annual, non-cash expense that is determined by

estimating the useful life of each asset. Depreciation represents a
decrease in the value to property and equipment to account for that
portion of their useful life that is used up during each accounting
period. Using the most common method called straight-line
depreciation, an asset with an estimated useful life of five years
would have one-fifth of its purchase price reflected as an expense in
each of five years. Land theoretically does not lose value over time
and therefore is not depreciated.

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• Other Expenses - other expenses related to operations, such as

training costs, foreign exchange losses, etc.

⇒ Net Income From Operations - income which is a direct result of the

micro-finance organization’s activities net of the expenses directly
related to those same activities.

⇒ Grant Revenue for Operations - funds donated to the organization to

cover operating expenses.

Comparative Income Statement

By recording net income earned by an organization, the Income Statement

measures the economic performance or level of self-sufficiency. It shows
the results of business activities of the organization during the specified
accounting period and the degree to which revenue generated from these
activities covered the organization’s costs.

Refer to the Sample Income Statement - Comparative on the next page. A

comparative statement allows management to see how revenue and
expenses have increased or decreased over time. This can then be
compared to the stated goals of the organization.

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SAMPLE INCOME STATEMENT (COMPARATIVE)

ABC Credit Programme

STATEMENT OF INCOME AND EXPENDITURE
For the period ended December 31, 1995
1995 1994 % Change

FINANCIAL INCOME:
Interest on Current & Past Due 15,400 12,000 + 28%
Loans
Interest on Restructured Loans 100 50 +100%
Interest on Investments 500 1,500 – 67%
Loan Fees/Service Charges 5,300 5,000 + 6%
Late fees on Loans 200 300 – 33%
Total Financial Income 21,500 18,850 + 14%
FINANCIAL COSTS:
Interest on Debt 3,700 3,500 + 6%
Interest paid on Deposits 0 0 0%
Total Financial Costs 3,700 3,500 + 6%

GROSS FINANCIAL MARGIN 17,800 15,350 + 16%

Provision for Loan Losses 2,500 3,000 – 17%
NET FINANCIAL MARGIN 15,300 12,350 + 24%
Operating Expenses
Salaries and benefits 6,000 5,000 + 20%
Administrative expenses 2,600 2,500 + 4%
Occupancy expense 2,500 2,500 0%
Travel 2,500 2,500 0%
Depreciation 400 300 + 33%
Other 300 300 0%
Total Operating Expenses 14,300 13,100 + 9%
NET INCOME FROM OPERATIONS 1,000 (750) + 233%
Income from Grants for Credit 0 950 – 100%
Services
Excess Of Income Over Expenses 1,000 200 + 400%
Source: SEEP Financial Services Working Group

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The Income Statement: EXERCISES

1. What is an Income Statement? How does it differ from a Balance Sheet?

2. Why is an Income Statement prepared?

3. Define and give examples of revenue and expenses.

4. Put (√ ) in the appropriate box:

ITEMS REVENUE EXPENSES

Interest earned on Interest Bearing Deposits
Salaries
Provision for Loan Losses
Depreciation
Interest paid on Debt
Interest earned on Current Loans Outstanding
Rent
Loan Fees
Bank Charges

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5. The following information is available for MicroFund Inc. for the period ended
December 31, 1993. On the basis of this information, prepare an Income Statement.

PARTICULARS $ PARTICULARS $
Salaries & Benefits: Provision for Loan Losses 1,000
- managers 1,000 Equipment Leasing 700
- credit officers 750 Interest on Current Loans 4,000
- admin. assistants 250 Utilities 35
Credit officer’s travel expen 45 Office Cleaning 25
Office stationary 250 Management Travel 100
Expense
Rent 425 Interest on Past Due Loans 500
Depreciation 110 Interest on Client Deposits 20
Interest on Debt 600 Educational Materials 200
Interest on Investments 200 Computer Software 500
Service Charges 1,500

MicroFund Inc.
INCOME STATEMENT
For the period ended December 31, 1993

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