The income statement is one of the three main financial statements. The income statement reports 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?
- Components of an income statement
- How to read an income statement
- How to prepare an income statement
- Purpose of income statements and how to use them
- Differences between an income statement vs. balance sheet
The income statement shows a business’s performance during a specific fiscal quarter or year. The income statement reports the net income for an accounting period by detailing your business’s revenues, gains, expenses, and losses. Analyzing the income statement can provide insights into the profitability of a company, as well as potential for future growth.
The income statement may also be referred to as the profit and loss statement, statement of earnings, or statement of operations.
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.
- Gains: Gains 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)
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.
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.
- Select the reporting period for the income statement.
- Create a trial balance report, which 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.
- Determine whether you will be preparing a single-step income statement or a multistep income statement—detailed in the next section.
- Follow the step-by-step instructions for the single-step or multistep income statement method.
- Finalize your income statement.
QuickBooks Online allows you to automatically track and organize your business’s accounting data, so you can easily access and review income statements. Use QuickBooks online to generate income statements and other key financial reports. Allow the software to do the heavy lifting for you, so you can focus on growing your business.
You can also download our free income statement template to streamline the process.
There are two methods for preparing an income statement in order to find net profit or loss: single step and multistep.
A single-step income statement is a much more simplified method, requiring fewer calculations. For single-step income statements, you need only one calculation. To determine net profit or loss, 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.
A multistep income statement is a much more detailed version and uses a more complex method of calculating net profit or loss. For the multistep income statement method, you will need to complete three steps:
- Find gross profit. Gross profit = net sales – COGS
- Find operating income. Operating income = gross profit – operating expense
- Calculate net income, which is income before taxes such as income taxes. Net income = operating income + nonoperating income
Typically, multistep income statements are used by larger businesses with more complex finances. This is because it provides greater detail, specifically:
- Division of revenues and expenses into operating and nonoperating subcategories
- Whether your business is efficiently using resources to generate revenue
- How profitable business activities are
If your business has a large variety of revenue streams, you may benefit from using a multistep income statement.
The income statement serves as a tool for understanding the profitability of your business. Profitability can be determined based on earnings per share (EPS). Earnings per share can be calculated by dividing the company’s profits by shares of common stock.
The income statement can also help you make decisions about 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
It can also help forecast business growth. Income statements should be generated quarterly and annually to provide visibility throughout the year.
The income statement should be used in tandem with the balance sheet and statement of cash flows for a clear view of business performance. With insights from all three of these reports, you can make informed decisions about how best to grow your business.
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.
The 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.
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