Also known as a profit and loss (P&L) statement, an income statement is a key financial document for your business. It is a clear picture that illustrates the profit and loss of your organization.
This information is important to know as it can help to make decisions regarding spending and investing, and can also help businesses to curb expenses. In conjunction with your cash flow statement and balance sheet, your income statement presents a full picture of your company’s financial health.
The basics: what is an income statement?
So, what exactly is an income statement or profit and loss statement?
The income statement is a recap of your company’s income and expenses over a specified period of time. This can be monthly, quarterly or annually. In income statement parlance, it is expressed as “for the year ending December 31, 2018,” for an annual income statement, or “for the three months ending September 30, 2018,” for a quarter running from July 1 through the end of September.
The period you choose depends on your needs. If you use the income statement to review your operations, select any period that works for you. This may be quarterly or even monthly.
If you need the statement for a loan application, typically the statement is year-to-date, ending with the most recent month; you will likely have to provide a statement for the prior full year as well.
How to make an income statement
First, you’ll need to decide how you want to list your entries on the statement. There are two options: Single-step Method and Multiple-step Method.
This type of system is normally used by service businesses. This method involves listing all your revenues and gains, then adding them up to find a subtotal of profit.
Then, you add up all of the expenses and losses. It is expressed in the following equation:
Net income (or loss) = (revenue + gains) – (expenses + losses)
A positive result is your net income. A negative result is your net loss.
This type of system is normally used by inventory-based businesses. In the multiple-step method, separate operating revenue and expenses from other revenue and expenses. This allows you to figure your gross profit, which is your net sales minus the cost of goods sold.
Again, you’ll total your revenue and expenses in the various categories, factoring in the cost of goods sold to arrive at net income or net loss.
Expenses to list on an income statement
Your profit and loss statement is comprised of two major categories: revenue and expenses. Let’s examine the specific numbers you should include for each of these entries.
Revenue is all income that a company receives. This includes:
- Operating revenue from the sale of goods and services.
- Non-operating revenue, such as interest received on loans made by the company or rent received from subleasing space.
- Gains on the sale of long-term assets (e.g. a vehicle, building, etc.) or other gains (e.g. a lawsuit recovery). Gains reported on the income statement is not the gross proceeds on a sale; it is the amount by which the proceeds exceed the asset’s value on the company’s books.
Revenue on the income statement is reported when the goods or services have been provided to the customer or client. Revenue for this purpose does not depend upon the receipt of payment.
For example, if you perform a service, account for revenue when the work is done, even though you have not yet received payment.
Similarly, if you are a retailer selling goods, report the revenue on the income statement when the goods are sold, even though the invoice for the transaction has not yet been paid. If you are paid on the spot—either with cash, a check, a credit or debit card payment, or other electronic transfer—then receipts and revenue are the same for the purposes of your income statement.
List and total up your expenses incurred to produce your company’s revenue. Separate your expenses into various categories to help you better see how money is being spent. Typical categories of expenses include:
- Operating expenses: The cost of goods sold if you have inventory, payroll, overhead (e.g. rent, utilities, insurance, communication costs, etc.) and marketing.
- Non-operating expenses: Interest expense, which accounts for interest payable for debt, such as bonds, loans, lines of credit, etc.
- Losses: Losses on the sale of assets and lawsuit damages. Losses reported on the income statement are the amount by which the proceeds are less than the asset’s value on the company’s books.
Expenses usually are reported when there is a liability for payment. For example, employee compensation is reported as an expense even if the company has not yet paid it.
Some expenses are matched to revenue for reporting purposes. For example, commissions owed to a salesperson are reported when the revenue from the sales are reported, even if the commissions have not yet been paid. Similarly, inventory expenses are reported in tandem with sales of inventory items.
Profit and Loss equation to remember:
Revenue gains (operating, non-operating, long-term assets) – Expense losses (operating, non-operating, losses) = Net Income or (Net Loss)
How to format your income statement
If you are using your income statement for strictly internal purposes, it doesn’t really matter how it’s formatted. The most important thing is to include all of the elements listed above.
However, if you are submitting your income statement (or profit and loss statement) for supporting materials relating to a loan or other third party purpose, it’s best to format your income statement per this free template.
The importance of your income statement
The income statement (or P&L statement) is a key component of a company’s financial statements, which should be prepared on at least a quarterly basis to evaluate the financial health, value, and growth of a company.
A proper Income Statement, when used in tandem with a Balance Sheet and Cash Flow Statement can provide you with the type of insight that leads to your organization’s growth and help ensure prosperity for years to come.