An income statement, also known as a profit and loss statement (or P&L), summarizes your company’s financial transactions. It shows you how much you earned and how much you spent for a specific reporting period.
An income statement is an important tool for any business owner because it lets you know whether your business made a profit or took a loss during the period being reported. It also helps evaluate past performance, predict future performance, and determine if changes need to be made.
Read on to learn what goes on an income statement, how to prepare an income statement, and how they can help you grow your business.
Key Points
• An income statement summarizes a business’s revenues, expenses, and profits over a specific period, providing insights into operational performance and profitability.
• It typically includes revenue, cost of goods sold (COGS), gross profit, operating expenses, non-operating income or expenses, and net income.
• Businesses can choose a single-step format, which simplifies calculations, or a multi-step format, which offers detailed breakdowns like gross and operating income.
• Public companies must prepare income statements in compliance with accounting standards like GAAP or IFRS, ensuring consistency and comparability.
• Income statements can be used to boost profits or help the company grow, especially if the business needs to take out a small business loan.
What Is an Income Statement?
An income statement shows your company’s income and expenditures, as well as if your company is making profit or taking a loss for a given period, which could be one month or one quarter. It is one of three key financial statements that help you understand the financial health of your business. The other two are the balance sheet and cash flow statement.
One way to think about a balance sheet vs an income statement is that a balance sheet tells you where you are right now, whereas an income statement tells you how you got there.
A simple, single-step income statement displays a company’s revenue, expenses, gains (income from other sources), and losses (one time or unusual costs) to arrive at a simple equation:
Net Income = (Total Revenue + Gains) – (Total Expenses + Losses)
Large corporations that have multiple business segments offering a mix of products and services will typically use a multi-step income statement, which separates operating and nonoperating revenues and expenses, and may also include gross profit, earnings before tax, taxes paid, and net profit.
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Understanding and Reading an Income Statement
An income statement consists of different line items. Each line item is a category (such as “expenses”), that may be further broken down into smaller categories (such as “wages” or “rent”).
As you read down an income statement, you follow a linear path from the “top line,” or the total money you’ve made before any expenses are taken into account, to the “bottom line,” which is the actual profit you earned. Along the way, you see how the top line amount gets whittled down as it’s used to pay for the cost of creating your products or services and keeping your company running.
While many business owners focus exclusively on the bottom line — their net profit, it can also be important to look at your sales revenue. Often, there’s only so much you can do to improve your bottom line by cutting expenses. At a certain point, you may also need to increase your revenue.
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What Are Income Statements Used for?
Income statements show a company’s sales, gains, losses, and overall profit or loss during a certain period. This information can be used to make financial projections. For example, if income statements show a 10% increase in sales year to year, it suggests the company can expect continued growth the following year. It’s not a guarantee, but a reasonable expectation.
This information can also be used to help business owners decide whether they can boost profits by increasing revenues, decreasing costs, or both. They can then refer to these statements to see if the strategies have paid off.
Below are some other ways in which an income statement can be useful for a small business.
Frequent Reports
Unlike many other financial statements, which are done annually, income statements are typically done quarterly or monthly. As a result, they can be more helpful in tracking business performance. Because of their frequency, income statements allow owners to pick up on small issues before they snowball into larger, and potentially more expensive, problems.
Pinpointing Expenses
When a company has a large number of expenses, it can be easy to lose track of where all of the money is going. An income statement analysis shows owners if expenses are on, over, or under budget and also highlights unexpected expenses.
Analysis of the Business
A company seeking an infusion of funds, either from an outside investor or a lender, will need to show how it’s performing financially. For example, when applying for a business loan, you will typically need to provide your income statements.
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Limitations in Income Statements
Income statements are not perfect, and there are limitations when it comes to them. The biggest limitation in income statements is making assumptions. Companies may assume an asset is going to depreciate less than it actually does, or they may predict how many returns will be made in a given quarter. More than likely, both of these figures will not be exact, which causes the income statement to be off.
Other limitations in income statements include them being time consuming to prepare and them not accurately reflecting how well (or poor) a company is performing. However, overall, income statements provide a good basis to the company’s financial health.
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10 Things to Include in an Income Statement
What goes on an income statement will depend on the type of business you own. However, the following categories are often included in an income statement.
1. Revenue of Sales
Sales revenue is how much money the company made from sales or services within a given time period. If your company has multiple revenue streams, each will be a line item under the “revenue” category of the income statement.
For some businesses, revenue needs to be further broken down into “operating” (revenue from the business’s core activity, such as selling a product) and “nonoperating” (revenue generated from other activities, such as installing or maintaining the product it sells).
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2. Gains
Also known as “other income,” gains are the result of an event that causes the company’s income to increase but has nothing to do with the company’s primary source of income. Gains may include:
• Selling of assets
• Lawsuits
• Investments in financial instruments
3. Cost of Goods Sold
Also referred to as COGS, the cost of goods sold is how much you pay to create your products. It only includes costs directly associated with those sales. For example, costs associated with goods may include labor, parts, and materials. Depreciation may also be included if you spent a large amount on an essential piece of equipment and you’re depreciating part of its value every accounting period.
If the company is a service business, this line item may be called cost of sales, and includes the cost of paying wages and providing the supplies you need to perform those services.
4. Gross Profit
Gross profit margin is sometimes included in an income statement and is calculated by subtracting the cost of goods sold (or cost of sales) from total sales revenue during the statement period. Gross profit doesn’t take into account general business expenses, interest payments on loans, or income tax.
5. Expenses
In addition to the COGS, you also want to include expenses that are not directly associated with your core business, such as marketing, rent, utilities, interest paid on a loan, general and administrative expenses, and research and development expenses. Tracking and categorizing expenses as you go will make creating this part of your income statement much easier.
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6. Advertising Costs
Advertising costs are an expense, and they include any costs associated with expanding your client base, such as marketing, promotion, social media, and advertising.
7. Administrative Costs
Administrative costs are often another line item under the “expense” category. These are costs that are unaffected by sales, and generally stay the same year to year. Administrative costs can include such things as salaries for employees, rent, utilities, and office supplies.
8. Net Income
A company’s net income is the “bottom line” of an income statement and is calculated by subtracting total expenses from total revenue. Net income tells you what your company actually earned (or lost) during the accounting period.
9. Earnings Before Tax
While not present on all income statements, earnings before tax (also known as EBT or pre-tax income) is calculated by subtracting expenses from a company’s total income before tax. It is sometimes included in a multi-step income statement.
10. Depreciation
Depreciation may be included as a line item on an income statement. It refers to the process of deducting a large business asset’s cost as a business expense over the period of its useful life. Rather than deducting the full cost of the asset in full as a one-time expense, the cost is spread out over a period of time.
Recommended: Comparing Amortization and Depreciation
Income Statement Example
Below is an example of a simple, single-step income statement for a small business.
| REVENUE | |
|---|---|
| $40,000 | Merchandise sales |
| 10,000 | Revenue from installation |
| 50,000 | Total revenue |
| EXPENSES | |
| $20,000 | Materials |
| 800 | Wages |
| 2,500 | Rent |
| 225 | Utilities |
| 225 | Utilities |
| 450 | Advertising costs |
| 350 | Administrative costs |
| 24,325 | Total expenses |
| GAINS | |
| $1,500 | Income from vehicle sale |
| LOSSES | |
| $1,500 | Lawsuit |
Building an Income Statement
When building an income statement, the first thing you want to do is determine your reporting period, whether that’s one month, one quarter, or one year. From there, calculate your total revenue during that time period.
Next, calculate your expenses. This includes what you spent on labor, materials, operating expenses, supplies, and more. Subtract your expenses from your revenue. This is called your gross profit, or earnings before interest and taxes.
Finally, calculate any interest charges and taxes. Subtract this from your gross profit, and you have your net income.
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GAAP Income Statements
GAAP, or generally accepted accounting principles, income statements are how U.S. public companies report their earnings. It’s a standardized set of rules, which allows for investors to analyze and compare company’s earnings against one another objectively.
GAAP income statements consist of several different business financial statements, including the balance sheet, the statement of owner’s equity, and the cash flow statement. This provides a detailed look at a company’s revenue and expenses, and standardizes how the information is presented to creditors and shareholders.
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The Takeaway
An income statement is a key source of information about factors responsible for a company’s profitability. It shows a company’s expenses, income, gains, and losses, which are then put into a mathematical equation to arrive at the net profit or loss for that time period (which might be one month or one quarter).
An income statement helps business owners decide whether they can boost profits by increasing revenues, decreasing costs, or both. Due to the frequency of these statements, they can help businesses make timely decisions that can help the company grow. For example, the business owner might decide to seek out a business loan in order to upgrade or streamline operations. This could help decrease costs and, in turn, improve net income.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
Is there a special format for income statements?
Income statements follow no universal format but typically include three sections: revenue, expenses, and net income. Businesses can use single-step or multi-step formats, with the latter providing detailed breakdowns like gross profit and operating income, offering greater insight into financial performance.
Is there a most important part of an income statement?
The most important part of an income statement is the bottom line — net income. This tells you exactly how much your business is making, after expenses.
What is the difference between a balance sheet and an income statement?
A balance sheet is a record of your company’s current debts, assets, and equity. An income statement tracks a company’s income and expenditures over a certain period of time and shows overall profit or loss during that period.
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