In order to gauge the performance and financial position of a company, three primary financial statements are used. One of these financial statements is the income statement. What is an income statement? Also referred to as a profit and loss or P & L statement, income statement is a summarized document of a company’s profit or loss during a specific period of time. All business revenues and operating expenses during the given period are what the income statement records.

A simple and straightforward report, the income statement informs about the cash generating ability of a business. An accounting scorecard, the profit and loss statement reflects the financial performance of a business including sales quantity, incurred expenses and net profit. A number of financial categories are what the P & L statement draws information from. The financial categories include:

  • Expenses
  • Revenues
  • Cost of goods
  • Capital (the depreciation amount)
  • Income Statement Examples

Income Statement Examples

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Often known as statement of earnings, the income statement is based on the following equation:

Revenues—Expenses=Net Income

Without generating revenue, no company can stay in business. Revenues are used for a number of purposes such as:

  • Paying expenses
  • Making debt interest payments
  • Paying tax owed to the government

After you’ve paid the cost of doing business, the amount that remains is known as net income. Theoretically, shareholders have access to net income. However, instead of paying out dividends, most companies choose to keep hold of earnings for future business investment purposes. Regardless of what companies choose to do with their earnings, income statements always include the same things.

The income statement for a given period of time includes a company’s total revenue during that period. Furthermore, it includes the cost of goods sold, the operating expenses, the interest expense and taxes. The income mentioned in the profit & loss statement includes all streams of revenue generated by the company. The cost of goods sold or COGS includes all the costs associated with the inventory products sale. Operating expenses include all labor and overhead expenses related to the business’ operations.

The decrease in the value of income generating capital assets is recorded in the income statement as depreciation. For tax deduction purposes, depreciation is used. Furthermore, it indicates money flow into new capital.

Together with the balance sheet, the income statement is the most important piece of information for determining the financial health of a company. Income statements are used for a number of reasons. This is what we’re going to discuss next.

What is an income statement used for?

Income statements can serve a number of purposes. First and foremost, using an income statement, you can track expenses and revenues. This will help you to gauge your business’ operating performance over a specific period of time. In order to determine the over or under budgeted areas of their business, many small business owners use P & L statements. Using these statements, the SBO’s are able to point out the items that are causing unanticipated outlays. Furthermore, with income statements, you can track pronounced increases in cost of goods sold or product returns which are sold as a sales percentage. You can also determine your tax liability with these statements.

Along with balance sheets, income statements are the most basic documents that potential lenders such as vendors, investors and banks require. In order to determine credit limits, the lender will use the financial information revealed by the two aforementioned documents.

The income that’s left after all the expenses of the company have been paid is what the income statement informs the investor about. The income that the investor is informed about is the net income. Often known as the ‘bottom line’, net income is an important indicator of a business’ overall profitability. Since it’s used to derive EPS or earning per share, market analysts spend a considerable amount of time discussing net income. EPS is important for investors because it tells them how much profit is paid out to each share they own.

The Income statement has a down side which is related to accounting adjustments. Net income in a given year can be distorted by accounting adjustments. For example, net income can overstate one-time gains. Furthermore, it’s a historical account of the company’s performance which means that it doesn’t reveal a company’s future earnings prospects or whether profits were merely due to an accounting method change. However, this does not undermine the importance of income statements. Therefore, knowing how to prepare an income statement is important. This is what we’re going to look at next.

Income Statement Templates

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Preparing an income statement

Also known as a consolidated statement of operations, an income statement has several components. In order to prepare the Profit & Loss statement, understanding each individual component is important. Let’s take a brief look at each component of the income statement.

Sales

The first component that we’re going to look at is sales. The revenue generated by the business is what the sales figure represents. The sales amount which is recorded is calculated as follows:

Total sales—sales discounts or any product returns

Cost of Goods Sold

The costs directly related to the manufacturing or acquiring of the products is referred to as cost of goods sold. The costs of the raw materials used in the manufacturing of your product as well as the expenses incurred during the manufacturing process are included in the COGS.

In case you’re preparing an income statement for a service business where you are the owner and the sole employee, the service expense will be zero (provided you do not pay yourself a salary). However, if you have employees or pay yourself a salary then you’ll need to include the labor cost (including benefits) in your cost of goods sold.

Gross Profit

Income taxes or operating expenses are not included in gross profit. Gross profit is calculated as follows:

Net sales—cost of goods sold

Operating expenses

We’ve already discussed this. However, there is no harm in looking at it again. Incurred in the business’ operation, operating expenses are daily expenses. Following are all the operating expenses included in the income statement.

Salaries expense:

This includes all the salaries including commissions and bonuses that you pay to your full and part-time employees.

Advertising expense:

Advertising expense includes all the costs you incurred to advertise/market your business.

Promotional expense:

This includes all expenses you incurred to promote your business such as the cost of giveaways and product samples used to sell or promote your product.

Utilities expenses:

This includes the phone, internet, electricity, air conditioning and heating costs you incurred for conducting your business.

Overhead costs:

Overhead costs are costs that cannot be associated to a particular function or product. Some examples of overhead costs are cleaning services and insurance. 

Rent expense:

This includes the rent you pay for your office or industrial space

Depreciation:

An annual expense, depreciation is the decrease in the value of income generating capital assets. Some capital assets prone to depreciation are buildings, automobiles, office furniture, machinery and computers.

Other costs:

This includes additional costs related to sale of your product. Some examples of such costs are equipment rental costs, client meals, travel expenses and printing costs.

Total expenses

Apart from interest expense and taxes, it includes all the expenses incurred in the running of a business.

Net income before Taxes

The amount of income earned by a business before tax is what this number represents. Net income before tax is calculated as follows:

Gross Profit—total operating expenses

Interest Expense

In order to pay the interest owed, money is paid to lenders or bondholders. The amount paid is recorded as interest expense in the income statement.

Taxes

This includes the income tax amount owed to the federal government. In some cases, it includes the tax amount owed to state or local government as well.

Net income

This is the final component of income statement. Net income shows the earnings after tax of the business.

There you have it—how to prepare an income statement. With that done, let’s take a look at two income statement types i.e. single-step income statement and multi-step income statement.

Single-step income statement

One of the two most commonly used income statement types, single -step income statement uses only one subtraction. In a single-step income statement, at the top of the income statement, all the gains and revenues are subtotaled together. Also, below revenues, all losses and expenses are subtotaled together. Once this is done, in order to arrive at the net income, the sum of losses and expenses is subtracted from the revenues sum. Following is how net income is calculated in single-step income statement.

Net income= (Revenues + Gains) − (Expenses + Losses)

Whether you use a single-step income statement or a multi-step income statement, the net come that you calculate will be the same. A single-step income statement does not calculate the gross profit of a business. This is its biggest drawback. On a single-step income statement, expenses and revenues aren’t broken down into different categories. This is the reason calculating ratios such as operating margin or gross profit from this income statement isn’t possible. In order to compute these ratios, additional documents are required. This is the reason the multi-step statement is used more than the single-step format. What is a multi-step income statement? Let’s take a look.

Sample Income Statement

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Multi-step income statement

Multiple sub-totals are what the multi-step income statement includes. It is one of the two of the two most commonly used income statement types. The other is of course the single-step income statement. In order to arrive at net income, more than one subtraction is used in multi-step income statement. Furthermore, compared to a single-step income statement, it provides more information such as the operating profit figures and the gross profit. There are two main sections of a multi-step income statement i.e. the operating section and the non-operating sections.

Operating section

Information related to expenses and revenues of the main business activities is what the operating section encompasses. Furthermore, in multi-step income statement’s operating section, operating profit figures and the gross profit are calculated. At the top of the income statement, all operating expenses are amassed. The selling expenses, cost of goods sold, and administrative expenses are what the operating expenses are sub-categorized into.

Expenses incurred to make sales are what selling expenses include. Some examples of these expenses are delivery expense, sales commissions, advertising expense, sales equipment depreciation expense and sales salaries. On the other hand, administrative expenses refer to the expenses related to general administrative activities. Examples of these expenses are office utilities expense, office supplies expense, office salaries and office building depreciation expense.

Non-operating section

Often labeled as other expenses and incomes, the non-operation section includes expenses and revenues earned incidentally i.e. not earned directly through the main business activities. This section is an important part of the multi-step income statement. Examples of the earnings and expenses included in this section are the interest or revenue expense and gains or losses on investments or fixed assets sales. Furthermore, this section also includes the infrequent and unusual expenses and revenues. An example of this is the loss caused by a natural disaster.

The multi-step income statement is beneficial in more than one ways. However, you must know what to include in it. Since it includes the gross profit margin and operating profit figures, multi-step income statement is preferred over the single-step statement. However, both of them are quite useful.

For any business and its stakeholders, income statements and balance sheets are valuable pieces of information. An income statement reveals the current financial health and cash generating ability of a business. Using a company’s income statement, lenders or investors determine whether the company is worth investing in. If you’re still aren’t sure how to prepare an income statement then you do not need to worry. We have many income statement templates that you can use to prepare the income statement of your company.

 

TemplateLab June 25th, 2017