Everything You Need to Know About the Income Statement (2022)

An income statement, which shows your revenue after expenses and losses, tells a story about the performance of your business over a certain time period, such as monthly, quarterly or annually. Once referred to as a profit-and-loss statement, an income statement typically includes revenue or sales, cost of goods sold, expenses, gross profits, taxes, net earnings and earnings before taxes. If you want a detailed analysis of your business's performance, the income statement is the report you need.

What is an income statement, and why is it useful?

The income statement is one of three financial statements that are important to businesses of all sizes. The other two, thebalance sheetand shareholder equity, go hand in hand with the income statement.

The income statement is often referred to as the statement of income, statement of earnings or statement of operations, but all of those terms mean the same thing: your profit and losses.

"The income statement reflects the income earned and expenses paid net of either profit or loss for a period," Mitchell Freedman, a certified public accountant atMFAC Financial Advisors, told business.com. "If you are selling services or merchandise, this is the measurement of how the company is performing."

(Video) The INCOME STATEMENT Explained (Profit & Loss / P&L)

Some small business owners may not think they need to worry about the income statement; after all, they know how much cash they have in the bank and how much is paid out. They also have a grasp on what they owe come tax time. But for any business owner who wants to identify expenses to cut or find new markets to enter, the income statement is invaluable. It can also help you stay on top ofcash flow, which is the lifeblood of all businesses.

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An income statement helps you do the following:

Track the cost of sales

Income statements let you track different types of sales and show the cost of those sales. That information can be used to gauge if your expenses are too high or your prices are too low. Take a restaurant that incurs an operating expense related to food and labor. Those expenses are listed on the income statement and can give you an idea of whether your pricing is spot-on or it's time to raise or lower prices.

"If it shows you're not making enough margin to cover the rest of your expenses, you may have to increase prices or try to find a way to decrease cost of sales," Freedman said. Without income statements, business owners wouldn't know that.

Assess the sustainability of the business

The income statement can help you determine if your business will generate revenue over the long haul. It can also inform decisions about entering new markets, investing in expensive equipment and taking out a business loan. If your income statement shows prolonged periods of losses, you may think twice about investing in the operations. If profit is surging, it may be time to expand or enter new markets.

Prepare for tax time

Death and taxes are life's two certainties. The income statement can help with the latter. Whether you're filing your income tax quarterly or annually, you're required to provide a lot of information about your business. With an income statement, the tax total is all there. [Read related article:Do Small Businesses Pay Taxes?]

Plan and forecast

The ability to plan and forecast is made much easier with income statements. Being able to analyze the trends in pricing and sales over an extended period can improve your ability to predict how your business will fare in the future. That will, in turn, dictate your next steps. The longer you have an income statement, and the more detailed it is, the easier it will be to spot trends and analyze gross margin performance.

Who uses an income statement?

The income statement is an important document for businesses of all sizes. Nevertheless, many small business owners don't think they need to create one. This approach is risky, Freedman said. "Too many businesses operate at the seat of their pants and start putting internal controls andaccounting systemsin place to catch up with growth," he said. "That can be very dangerous."

(Video) The Income Statement: Everything You Need to Know

What goes into an income statement?

The income statement includes several pieces of key financial information that's used to calculate profit and losses. They include the following items:

Operating revenue:Operating revenue includes all of the money the business earns from providing a service or selling goods.

Nonoperating revenue:This is revenue earned through noncore business activities, such as rent from a property the business owns or royalties from a partnership.

Gains:Often called other income, this is money the business made outside of its core operations. For instance, it could be money made from selling off land or an old vehicle.

Expenditures:Expenditures are money spent on goods or services to run the business. They are recorded at the time of purchase. Expenditures differ from expenses, which are typically offset over a period. For example, if you spend $10,000 on a copy machine and pay for it on the spot, that would be listed as an expenditure. But if you pay off the printer over several years, it's an expense.

Cost of goods sold:Known as COGS, these are the costs associated with selling your products. They include the materials to develop your goods and the labor to get them in the market.

Operating expenses:These are the costs not linked to the goods or services you're providing. They can include rent, office supplies and utilities, among other things.

Depreciation:These are expenses that are spread out over a long period of time. The value declines as the equipment or vehicle ages. Depreciation varies depending on the type of business you are operating.

Owner's draw:This is the money you take out of the business to pay yourself a salary.

(Video) The INCOME STATEMENT for BEGINNERS

Earnings before taxes:This refers to your income before you pay any taxes on it.

Gross profit:Calculated by subtracting the cost of goods sold from revenue, gross profit is the profit the company makes.

Net income:Net income is the income left over after you subtract all of your expenses from your gross profits. It's the most important line of the income statement. If your net income is positive, your business is doing OK. If your net income is negative, you may need to take a deeper look at operations. It's common for businesses just starting out to have a loss.

What are the types of income statements?

There are several types of income statements you can employ to stay on top of profit and losses, with varying degrees of complexity. For small business owners, the single-step income statement and the multistep income statement are the most popular.

Single-step income statement

A single-step income statement is the easiest one to create because it uses one calculation to ascertain the profit or loss of the business. Here is the equation used with a single-step income statement:

Net income = (revenues + gains) - (expenses + losses)

This type of income statement is simple to understand and easy to prepare, which is why it's commonly used by small businesses and sole proprietors that don't have several different sales lines. Companies that sell goods and services may opt to use the multistep income statement.

Multiple-step income statement

Used by businesses that sell tangible goods or have more than one line of business, the multistep income statement, as its name implies, uses multiple steps instead of one. With this type of income statement, the operating revenue and operating expenses are separated from the nonoperating revenue and nonoperating costs, losses and gains.

By separating operating income from nonoperating income, a business owner can get a deeper understanding of his or her operations. The calculations to determine profit or loss with a multistep income statement include the following:

(Video) Income statement explained

Gross profit = net sales - cost of goods sold

Operating income = gross profit - operating expenses

Net income = operating income + nonoperating income

What is an example of an income statement?

While there are different types of income statements, they all include the key information listed above. Below is asample income statement provided by SCORE, the nonprofit small business mentoring group.

Everything You Need to Know About the Income Statement (1)

Source: Image courtesy of SCORE

What are best practices for income statements?

Income statements are among the most important financial statements small business owners should maintain. But if you make a lot of mistakes, it could paint an inaccurate picture of how your business is performing – which is why it's important to follow these three best practices when creating your income statement.

1. Choose your reporting period.

Before you can even input your revenue or expenses, you have to choose the reporting period the information will cover: monthly, quarterly or annually. Unlike publicly traded companies, most small businesses aren't required to report their income statements quarterly, but updating the information regularly can be a great way to pinpoint trends in revenue and expenses.

2. Consider accounting software.

Thanks to cloud-based software, the days of jotting down your revenue and expenses in a physical ledger are over. These days, there areaffordable, cloud-based accounting servicesfor every size business. Going this route enables you to automate a lot of the work.

(Video) Introduction to the Income Statement

"If you use a cloud accounting program, it's a living, breathing document that can be updated in near real time," said Dennis Sherrin, a certified public accountant and past chairman of theAlabama Society of CPAs.

3. Seek out help from professionals.

Your income statement must be accurate for you to be able to assess your business's financial performance. For small business owners who are focused on growing their enterprise, crafting and updating an income statement may be daunting. If you fall in that camp, it's a good idea to call in the professionals.

"It's absolutely important that you have someone help you create your business's income statement according to the industry you operate in," Sherrin said, noting that a construction company's income statement is different from a retailer's, for example. "Having someone set it up consistent with the industry they are operating in allows them to compare and benchmark it" against rivals, he said.

FAQs

What information does an income statement provide answer? ›

The income statement shows a company's expense, income, gains, and losses, which can be put into a mathematical equation to arrive at the net profit or loss for that time period. This information helps you make timely decisions to make sure that your business is on a good financial footing.

What is the most important part of the income statement? ›

Net income: Net income is the income left over after you subtract all of your expenses from your gross profits. It's the most important line of the income statement.

What are the main 4 components of income statements? ›

The income statement presents revenue, expenses, and net income. The components of the income statement include: revenue; cost of sales; sales, general, and administrative expenses; other operating expenses; non-operating income and expenses; gains and losses; non-recurring items; net income; and EPS.

What information is needed to complete an income statement? ›

Preparing an income statement involves compiling a list of revenue, expenses, losses and gains. Once these items are consolidated, they're organized into categories and added together to calculate net income over the time period covered by the statement.

What 3 things are on an income statement? ›

Revenues, Expenses, and Profit

Each of the three main elements of the income statement is described below.

What accounts are in income statement? ›

The income statement accounts most commonly used are as follows:
  • Revenue. Contains revenue from the sale of products and services. ...
  • Sales discounts. ...
  • Cost of goods sold. ...
  • Compensation expense. ...
  • Depreciation and amortization expense. ...
  • Employee benefits. ...
  • Insurance expense. ...
  • Marketing expenses.
22 May 2022

What is income statement in simple words? ›

An income statement shows a company's revenues, expenses and profitability over a period of time. It is also sometimes called a profit-and-loss (P&L) statement or an earnings statement. It shows your: revenue from selling products or services.

What numbers are important in income statement? ›

(1) Revenue, (2) expenses, (3) gains, and (4) losses. An income statement is not a balance sheet or a cash flow statement.

What is the most important number in financial statement? ›

The 9 Most Important Financial Numbers Explained
  • Cash Flow. It's number one for a reason. ...
  • Net Income. Also known as net profit or net earnings, your net income is quite related to your cash flow. ...
  • Profit and Loss. ...
  • Cost of Revenue. ...
  • Gross Margin. ...
  • Total Inventory. ...
  • Days Sales Outstanding. ...
  • The Quick Ratio.
5 Dec 2016

Which item would not be found on an income statement? ›

Answer and Explanation: (b) Dividends would not be found on an income statement. An income statement shows all the revenues and expenses of a company for a period of time, typically for a year.

What are the two key components of an income statement? ›

Key elements of the income statement include revenue and expenses. Combined, these numbers yield the net income (or loss).

What are the 5 elements of net income? ›

Types of Net Income
  • Cost of goods sold.
  • Operating expenses.
  • Interest.
  • Taxes.
  • Dividends on preferred stocks.

What is the purpose of income statement in a business? ›

The purpose of an income statement is to show a company's financial performance over a period. It tells the financial story of a business's activities. Within an income statement, you'll find all revenue and expense accounts for a set period.

Which form of income statement is required? ›

The multi-step income statement is the standard format of an income statement prepared by big corporations and all publicly listed companies. Three equations are used to derive the net income using the multi-step income statement.

What are the most common income statement items? ›

The most common income statement items include:
  • Revenue/Sales. Sales Revenue is the company's revenue from sales or services, displayed at the very top of the statement. ...
  • Gross Profit. ...
  • General and Administrative (G&A) Expenses. ...
  • Depreciation & Amortization Expense. ...
  • Interest. ...
  • Income Taxes.
7 May 2022

Is income statement same as profit and loss? ›

Profit and Loss (P&L) Statement

A P&L statement, often referred to as the income statement, is a financial statement that summarizes the revenues, costs, and expenses incurred during a specific period of time, usually a fiscal year or quarter.

How do you read an income statement? ›

Your income statement follows a linear path, from top line to bottom line. Think of the top line as a “rough draft” of the money you've made—your total revenue, before taking into account any expenses—and your bottom line as a “final draft”—the profit you earned after taking account of all expenses.

How is income defined? ›

The term “income” generally refers to the amount of money, property, and other transfers of value received over a set period of time in exchange for services or products. There is no single, standard definition: income is defined according to the context in which the concept is used.

What are the 3 most important financial statements? ›

The income statement, balance sheet, and statement of cash flows are required financial statements. These three statements are informative tools that traders can use to analyze a company's financial strength and provide a quick picture of a company's financial health and underlying value.

What are the 4 most important financial statements? ›

But if you're looking for investors for your business, or want to apply for credit, you'll find that four types of financial statements—the balance sheet, the income statement, the cash flow statement, and the statement of owner's equity—can be crucial in helping you meet your financing goals.

What ratio is the most important? ›

Return on equity ratio

This is one of the most important financial ratios for calculating profit, looking at a company's net earnings minus dividends and dividing this figure by shareholders equity. The result tells you about a company's overall profitability, and can also be referred to as return on net worth.

What period of time does the income statement always cover? ›

An income statement provides an overview of company financial activity during a given period of time, comparing incoming revenue with outgoing expenses. It can cover any period of time for which you want information, from a particular week to a span of multiple years.

What are 2 most important financial statements sheets? ›

Key Takeaways

The balance sheet provides an overview of assets, liabilities, and shareholders' equity as a snapshot in time. The income statement primarily focuses on a company's revenues and expenses during a particular period.

Which function of financial statement is the most important? ›

Uses of Financial Statements

Determine the financial position of the business: The most important use of the financial statements is to provide information about the financial position of the business on a given date.

Which equation represents an income statement? ›

The basic formula for an income statement is Revenues – Expenses = Net Income. This simple equation shows whether the company is profitable. If revenues are greater than expenses, the business is profitable.

Does cash go on income statement? ›

What's included in an income statement? The income statement focuses on four key items: sales revenues, expenses, gains and losses. It does not concern itself with cash or non-cash sales, or anything regarding cash flow.

Which of the following is true about income statement? ›

The statement which is true regarding income statement is that the income statement is sometimes called the statement of operations.

What factors affect net income? ›

Net income is found by taking sales revenue and subtracting COGS, SG&A, depreciation, and amortization, interest expense, taxes and any other expenses.

What are the five source of income? ›

The five main heads of income according to the above-mentioned Section 14 for the computation of the Income Tax in India are:
  • Income from Salary.
  • Income from House Property.
  • Income from Profits and Gains of Business or Profession.
  • Income from Capital Gains.
  • Income from Other Sources.

How often are income statements required? ›

An income statement is a financial report detailing a company's income and expenses over a reporting period. It can also be referred to as a profit and loss (P&L) statement and is typically prepared quarterly or annually. Income statements depict a company's financial performance over a reporting period.

Why was the income statement created? ›

The purpose of the income statement is to show the reader how much profit or loss an organization generated during a reporting period.

Who prepares income statements? ›

Who Prepares a Company's Financial Statements? A company's management has the responsibility for preparing the company's financial statements and related disclosures. The company's outside, independent auditor then subjects the financial statements and disclosures to an audit.

How many income statements are there? ›

They show you where a company's money came from, where it went, and where it is now. There are four main financial statements.

Are all income statements the same? ›

While almost no two income statements look the same, they all possess a common set of data: total revenue, total expenses, and net income.

Which income statement is prepared first? ›

First: The Income Statement

This breaks down your company's revenues and expenses. You need to prepare this first because it gives you the necessary information to generate the other financial statements. Making your income statement first lets you see your business's net income and analyze your sales vs. debt.

How is an income statement organized? ›

The heading of the income statement should contain three crucial elements of information: the name of the company involved, the title of the statement identifying it as an income statement, and the specific 12-month period during which the income was earned.

What information does an income statement provide quizlet? ›

An income statement reports the revenues earned less the expenses incurred by a business over a period of time. Ex. Rent Expense, salaries expense, utilities expense, rental revenues, total revenues. Reports info about how retained earnings changed over the reporting period.

What does an income statement show quizlet? ›

The Income Statement shows a company's revenues and expenses over a period of time. The last line item on the income statement is net income. This shows how profitable a firm has been over a period.

What does an income statement represent quizlet? ›

Income Statement: An income statement represents a firm's operating results over a period of time (a fiscal year or quarter). It summarizes a business's profitability (revenue minus expenses) within a time period.

What is the source of information used to prepare the income statement? ›

Information on sales revenue and expenses from both your accounting journals and the general ledger are used to prepare the income statement. It shows revenue from primary income sources, such as sales of the company's products, and secondary sources, like if the company sublets a portion of its business premises.

What is another name for income statement? ›

An income statement shows a company's revenues, expenses and profitability over a period of time. It is also sometimes called a profit-and-loss (P&L) statement or an earnings statement. It shows your: revenue from selling products or services.

Which of the following best explains the main purpose of an income statement? ›

The purpose of an income statement is to show a company's financial performance over a period. It tells the financial story of a business's activities.

Which types of accounts appear on the income statement quizlet? ›

(*Revenue and expense accounts flow into the income statement, and asset, liability, and stockholders' equity accounts flow into the balance sheet. Net income and the dividends account flow into the statement of retained earnings.)

What is only on an income statement? ›

The income statement focuses on four key items: revenue, expenses, gains, and losses. It does not differentiate between cash and non-cash receipts (sales in cash vs. sales on credit) or cash vs. non-cash payments/disbursements (purchases in cash vs. purchases on credit).

Which best describes the income statement? ›

The Income Statement is one of a company's core financial statements that shows their profit and loss over a period of time. The profit or loss is determined by taking all revenues and subtracting all expenses from both operating and non-operating activities.

Does an income statement show the total assets? ›

The income statement provides an overview of the financial performance of the company over a given period. It includes assets, liabilities and shareholder's equity, further categorized to provide accurate information. It includes revenues, expenses, and gains and losses realized from the sale or disposal of assets.

Which financial statement is the most important one explain? ›

The most important financial statement for the majority of users is likely to be the income statement, since it reveals the ability of a business to generate a profit. Also, the information listed on the income statement is mostly in relatively current dollars, and so represents a reasonable degree of accuracy.

How is the income statement linked to the balance sheet? ›

There is a connection between the balance sheet and income statement when double-entry accounting is used. In essence, increases in revenue and gains as reported on the income statement cause stockholders' equity to increase on the balance sheet.

What is another name for the income statement quizlet? ›

Another name for an income statement is a profit and loss statement.

What is the importance of income? ›

If you are the breadwinner of your family, your income is the steering wheel that keeps the family vehicle in motion. Just imagine if something untoward happens to you, how will the family cope with life? If the flow of income is interrupted or disrupted, it will throw life totally out of gear.

Why income statement is prepared first? ›

You need your income statement first because it gives you the necessary information to generate other financial statements. Revenues would be any sales that your business generates. Expenses could be various operating costs, like inventory, rent, or utilities.

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