Income statement reports show financial performance based on revenues, expenses, and net income. Used correctly, the income statement is a valuable tool. By regularly analyzing your income statements, you can find areas of improvement, compare your business against competitors, and gather other key financial insights.
For a better understanding of how your business can create and use income statements, read this guide from start to finish. To learn about a specific aspect of income statements, use the links below:
What is an income statement?
The income statement, also known as a profit and loss statement, shows a business’s financial performance during a specific accounting period. The income statement reports the net income by detailing a business’s revenues, gains, expenses, and losses. Put simply, an income statement follows this equation:
Total Revenue – total expenses = net income
Analyzing the income statement can provide insights into the profitability of a company, as well as the potential for future growth.
What are income statements used for?
The income statement serves as a tool for understanding the profitability of your business. The income statement can also help you make decisions about your spending and overall management of business operations. The information gleaned from the income statement can help you determine:
- How you can improve your business’s financial performance in the upcoming quarter or year
- Which business activities to allocate more spending to
- Where you need to cut expenses
- How you can more efficiently use business resources
Income statements can also help forecast business growth. Income statements should be generated quarterly and annually to provide visibility throughout the year. For small businesses, generating monthly income statements can help to identify financial trends.
Using information on the income statement, companies can use earnings per share (EPS) to measure profitability. Earnings per share can be calculated by dividing the company’s profits by shares of common stock.
Components of an income statement
The elements of an income statement include revenues, gains, gross profit, expenses, losses, and net income or loss. Let’s define the main components of the income statement:
- Revenues: Revenue is all income generated by the sale of the business’s primary goods or services. Revenue may also be referred to as the “top line” because it is the first line on the income statement.
- Operating revenue is defined as revenue from primary business activities.
- Non-operating revenue is the revenue gained from secondary activities such as interest, rental income, partnerships, and more.
- Gains: Gains, also known as other income, are the earnings produced through aspects other than the sale of your main good or service. For example, selling off assets can be categorized under gains.
- Gross profit: Gross profit is the sum of revenue minus cost of goods sold (COGS)—the direct costs related to producing goods or providing services.Gross profit = revenue – COGS
- Expenses: Expenses include all operating expenses required to run your business. Operating expenses—also known as selling, general, and administrative expenses—include costs such as advertising expenses, insurance, and rent. Note that the costs associated with producing your goods or providing services are not included in the expenses section of the income statement.
- Losses: Losses include the money lost through activities outside of the sale of your primary goods or services. For example, paying out a lawsuit settlement is considered a loss.
- Net income or loss: Net income — or loss — is what is left over after all revenues and expenses have been accounted for. If there is a positive sum (revenue was greater than expenses) it’s referred to as net income. If there’s a negative sum (expenses were greater than revenue during that period) then it’s referred to as net loss.
Net income = (total revenue + gains) – (total expenses + losses)
How to read an income statement
Here are some pointers to help you read and understand your income statement:
- Read the income statement from top to bottom, the line items are placed in logical order.
- As you move down the income statement, you’ll see the money you’ve brought in from your core business operations. Then, you’ll factor in income from other business activities and your expenses to arrive at your profit or “bottom line.”
- Once those factors are accounted for, you’ll have your net profit before taxes, also known as pretax income.
- And finally, at the very bottom, you’ll have your net income.
- If net income is negative, that means you’re operating at a loss—you’re spending more than you’re bringing in. Ideally, you want your net income to be positive, but at the beginning stages of your business, that may not be possible.
How to select the income statement type that’s best for you
When deciding how you’d like to report your net income, it’s important to consider the pros and cons of both the single-step and multi-step income statements.
Single-step vs. multi-step income statements: Which should you use?
While single-step income statements are the simplest and most commonly used for small businesses, multi-step income statements are great for small businesses with several income streams.
For small businesses with few income streams, we recommend generating single-step income statements on a regular basis, and a multi-step income statement annually. This way, you’re keeping track of your finances monthly and/or quarterly and saving the heavy-lifting for just once a year.
If you have more than a few income streams or a complicated financial landscape, we suggest using multi-step income statements to get a better view of your profits and losses.
Benefits of a multi-step income statement for small businesses
Typically, multi-step income statements are used by larger businesses with more complex finances. This is because they provide greater detail. However, multi-step income statements can benefit small businesses that have a large variety of revenue streams. Below are several ways multi-step income statements can benefit your small business.
- Division of revenues and expenses: A multi-step income statement breaks down revenue streams into operating and non-operating subcategories—giving you a more detailed view of what’s coming in.
- Use of resources to generate revenue: A multi-step income statement will give you a look into how well your business is utilizing internal or external resources to generate revenue.
- Profitability of business activities: The greater breakdown of expenses provides a better understanding of how business activities such as administration fees or travel expenses are affecting your bottom line.
Benefits of a single-step income statement for small businesses
- Saves time and resources: A single-step income statement is performed by calculating just one formula, making it a much quicker process and requiring less preparation than the multi-step option.
- Clear breakdown of finances: Single-step income statements break down a business’s financial standing into just 4 categories: revenue, expenses, gains, and losses. This paints a much more concise picture.
- Easy to read: Because all expenses are grouped together in the single-step statement, it’s much easier to read and understand. This is ideal for small businesses that don’t have the resources to hire an accountant or bookkeeper.
Why are income statements important for small businesses?
An income statement provides a clear picture of your business’s financial position by showing whether or not your business is profitable. For small businesses, income statements can provide much more information than profitability. Here’s how periodically generated income statements can impact your business:
Forecast future profitability
By generating income statement reports and other financial statements on a regular basis, you’ll be able to analyze the statements over time to see whether or not your business is turning a profit and use that information to predict future numbers. Financial projections help you make more informed decisions about your business.
Identify cash flow issues
For small businesses, cash flow is often more important than profits or assets. When used in conjunction with the other financial statements, income statements are a great way to get a clear view of your cash flow.
Good for credit
For many small businesses, financial statements are needed to apply for credit or to provide financial information to a potential lender. A consistent history of income and profitability can help move those processes along.
Accurate records of expenses, revenues, and credits are required for tax purposes and help keep you in compliance with tax regulations.
Ultimately, income statements keep track of everything going in and out and can act as a guide for business decisions—big or small.
How to prepare an income statement for your small business
Preparing financial statements can seem intimidating, but it doesn’t have to be an overwhelming process. We’ve broken down the steps you’ll need to follow when preparing your income statement, as well as some helpful tips.
1. Select the reporting period for the income statement
Income statements can be prepared monthly, quarterly, or annually, depending on your reporting needs. Larger businesses typically run quarterly reporting, while small businesses may benefit from monthly reporting to better track business trends.
2. Create a trial balance report
A balance report details your end balance for each account that will be listed on the income statement. This can be easily done with accounting software, like QuickBooks Online. A balance report provides all of the end balances required to create your income statement.
3. Determine if you’ll be preparing a single-step or a multi-step income statement and follow those steps
Single-step income statements can be used to get a simple view of your business’s net income. These take minimal time to prepare and do not show operating vs. non-operating costs.
A multi-step income statement calculates net income and separates operational income from non-operational income—giving you a more complete picture of where your business stands. You can also skip to:
4. Finalize your income statement
Give your statement a final QA either manually or using an automated platform. Using software allows you to automatically track and organize your business’s accounting data so you can easily access and review income statements.
You can use QuickBooks Online to generate income statements and other key financial reports (allowing you to focus on growing your business). You can also download our free income statement template to streamline the process.
How to prepare a single-step income statement
A single-step income statement is a one-step, simplified approach to viewing your net profit or loss. Single-step income statements include revenue, gains, expenses, and losses. While a multi-step income statement lays out several categories of expenses, single-step statements group all expenses into one. For single-step income statements, you need only one calculation—net income. To determine net income, you simply subtract all your expenses from total revenue, using the following equation:
Net income = (revenues + gains) – (expenses + losses)
Single-step income statements are easy to prepare and easy to interpret. In many cases, single-step income statements are sufficient for small businesses. Note that single-step income statements will show strictly operating costs.
How to prepare a multi-step income statement
A multi-step income statement is a much more detailed version and uses a more complex method of calculating net profit or loss. Multi-step income statements add in four measures of profitability: gross, operating, post-tax, and pre-tax, and separate operating and non-operating expenses—giving a more detailed financial picture.
For the multi-step income statement method, you will need to complete three additional steps:
1. Find gross profit
- Gross profit = net sales – COGS
2. Find operating income
- Operating income = gross profit – operating expense
3. Calculate net income
- Net income = operating income + non-operating income
Differences between an income statement vs. balance sheet
The income statement and balance sheet are two of the main financial statements your business will use—in addition to the cash flow statement. However, that’s where their similarities end.
The key differences between the income statement and balance sheet include:
- Purpose: The income statement showcases the company’s financial performance, whereas the balance sheet showcases the company’s financial position.
- Key takeaways: Business owners can determine financial shortcomings and how to improve performance using the income statement. The balance sheet helps business owners determine whether they can meet their current financial obligations.
- Components: The income statement includes the company’s revenues and expenses, while the balance sheet shows assets, liabilities, and equity.
- Reporting timeframe: The income statement is used to report expenses and revenue during a specific period of time. The balance sheet is used to reflect current financial circumstances.
While these statements provide different insights, they are both used by investors and lenders to make decisions about your business.
Start generating income statements today
An income statement is a valuable tool for guiding your business’s financial decisions. While you can prepare income statements on your own, it is much more streamlined and accurate when you use accounting software. With QuickBooks Online, you can keep tabs on your financial standing, while spending less time crunching numbers and more time building your business.