The purpose of an income statement is to provide users with information about a business's profitability over a specific reporting period. However, there are two formats that can be used to prepare an income statement—the single step format and the multi step format—and many small business users wonder which format their businesses should be using. While both formats have advantages and disadvantages, your choice of format depends on what you intend to use your income statement for.
Single step income statement
What is a single-step income statement? If you're a sole proprietor or a partner in a partnership, it's likely that your business's income statement is being presented in this simplified format. Unlike the multi-step income statement, the single-step format is more of a basic income statement, without a high level of detail:
- A focus on net income. In the single-step income statement, expenses and losses are subtracted from revenue and gains to come up with one number, the business's net income.
- Not highly detailed. It's not uncommon to see a single-step income statement that presents revenue and gains on one line and expenses and losses on another line, but even when revenue and expenses are broken down, the single-step format won't approach the level of detail offered by the more complex multi-step format.
- Advantages. One clear advantage of the single-step format is that it's an easy statement to prepare. Its focus on net income is also particularly useful when a user is making an assessment that depends on net income, or the bottom line.
- Disadvantages. While its simplicity is an advantage, it also becomes a disadvantage in situations where the user requires more information. Many financial decisions do require more information about a business's financial health than net income alone can provide. When assessing a business's financial performance to assist in making such decisions, the single-step format will not be the most beneficial format.
Multi-step income statement
With its more detailed approach to income numbers, the multi-step income statement is the format that corporations are required to use. Because this format provides users with more information than the single-step format, businesses with simpler structures, such as a sole proprietorship or partnership, may occasionally prefer to use this format in order to provide potential investors or creditors with the more detailed information they may require:
- More detail. Not only does the multi-step format offer an itemized listing of revenue and expenses, but also the revenue and expenses are further broken down into specific categories.
- Gross profit. Unlike the single-step format's focus on net income, the multi-step income statement uses the additional level of detail to calculate two more income-related figures. The first figure calculated is gross profit, which is determined by subtracting the cost of goods sold from net sales.
- Operating income. Another useful income figure calculated by the multi-step format is operating income. A business's operating income is calculated by subtracting its operating expenses from its gross profit.
- Advantages. It's no surprise that the main advantage of the multi-step format comes from the in-depth figures it provides. Users such as potential investors or creditors find the additional information on gross profit and operating income particularly helpful in assessing the financial health of a business.
- Disadvantages. The detail provided by the multi-step format also can be a drawback. Preparing a multi-step income statement is a more complex and time-consuming process than the preparation of the single-step format.
Which income statement format should you use?
Simpler business structures, such as sole proprietorships and partnerships, have the option of using either the single-step or the multi-step format. However, while the single step format is an easier income statement to prepare, if you will be providing potential creditors or investors with financial statements so they can assess the viability of your business, the added detail provided by a multi-step income statement may make this format the better option of the two.
Knowing how—and when—to use the statements you've created is as important as creating them correctly in the first place.