An income statement reports a business’s revenues, expenses and overall profit or loss for a specific period of time. It’s one of the three major financial statements that small businesses prepare to report on their financial performance, along with the balance sheet and the cash flow statement. An income statement doesn’t just show the total profit or loss a company generates, it also shows the costs associated with earning that revenue. An income statement is also referred to as a profit and loss statement.
These topics will teach you what an income statement is and why they’re important for financial accounting:
What Is an Income Statement?
An income statement is a financial report that details a business’s profitability during a specific period of time. You can create an income statement on a monthly, quarterly or annual basis. They can follow one of two reporting formats:
SINGLE-STEP INCOME STATEMENT
A single-step income statement gives a simplified account of your business’s financial activity. As the name suggests, it uses just one step to calculate net income, which is the final line item on the income statement. This is the equation you can use to determine net income for a single-step income statement:
Net Income = (Revenues + Gains) – (Expenses + Losses)
The single-step income statement is the most common format used by small businesses. It reports all the relevant details for service-based businesses and companies that have relatively simple operations.
MULTI-STEP INCOME STATEMENT
A multi-step income statement is the more complex of the two formats and offers more detail about a business’s financial activities. The multi-step income statement uses three separate steps to calculate the net income:
Gross Profit = Net Sales – Cost of Goods Sold
Operating Income = Gross Profit – Operating Expenses
Net Income = Operating Income + Non-Operating Items
Multiple-step income statements separate operating revenue and operating expenses from non-operating revenue and non-operating expenses. That way, you get a better picture of how the company’s core business activities are driving profits.
Multi-step income statements tend to be used by large manufacturers and retailers with complex business operations.
What to List on an Income Statement?
The information that’s listed on your business’s income statement will vary depending on the format you choose and the specific details of your business’s operations.
THE FOLLOWING ARE SOME COMMON ACCOUNTING ITEMS THAT CAN BE INCLUDED ON INCOME STATEMENTS:
Revenue or Sales: Your revenue earned through selling your products or services. This is the first section that appears on the income statement.
Cost of Goods Sold: The total of the direct costs incurred to sell your products and earn revenue. This can include the cost of labor and materials.
Gross Profit: Gross profit is calculated by subtracting the cost of goods sold from your revenue. This equation is included on a multi-step income statement only.
Advertising and Promotions Expenses: Costs associated with marketing your business to attract clients. This can include payment for digital or print advertising.
General and Administrative Expenses: The administrative costs associated with running your business, including salaries, rent, office supplies and travel expenses.
Depreciation Expenses: Depreciation refers to the practice of spreading out the cost of a long-term asset over its useful life span. It’s often done with vehicles and large equipment.
Earnings Before Tax: Your pre-tax income. This is usually the second-to-last line item included on an income statement.
Net Income: The total revenues minus total expenses. This is the last line item on an income statement. If the number is positive, your business is reporting a profit. If it’s negative, you’re recording a loss for the reporting period.
What is the Importance of an Income Statement?
An income statement is an important financial statement as it shows the overall profitability of a company. You can also use the income statement to analyze how efficiently your business is able to translate expenses into revenues.
An income statement can help you determine if your business has the ability to generate earnings in the long term and can help you make important business decisions, like whether to invest in new, expensive equipment or whether to wait until your company is in a better financial position.
