An income statement is a financial statement that shows your revenue after expenses for a particular period, such as a month, quarter, or year. Preparing one is simple if you stay on top of your company's bookkeeping.
What Is an Income Statement?
An income statement is one of the four primary financial statements. The other primary financial statements are the balance sheet, the statement of cash flows, and the statement of shareholder's equity.
The income statement may go by other names, including the profit and loss statement or the statement of earnings. No matter the name, it's a measure of your company's performance.
You can use an income statement to:
- Estimate what you'll owe at tax time
- Identify expenses to cut
- Stay on top of the cost of generating sales
- Assess the sustainability of the business
- Plan for and forecast revenues and expenses
How to Prepare an Income Statement
The income statement includes several key pieces of information necessary to calculate your business's profits and losses. The following steps will help you prepare an income statement for your business.
1. Print the Trial Balance
Go into your accounting software and print a trial balance for the period end. The trial balance is a summary report that contains ending balances for every account in the general ledger.
2. Determine Your Total Revenue or Sales
Your trial balance may include one or more revenue or sales accounts. Add up all the revenue line items on the trial balance and enter the total on the revenue line item of your income statement.
3. Determine Your Cost of Goods Sold
Cost of goods sold (COGS) consists of all of the direct costs associated with producing your business's goods or services. These costs typically include direct labor, direct materials, freight, storage, packaging, and factory overhead.
Add up all the cost of goods sold line items on your trial balance and enter the total into the cost of goods sold line on your income statement directly under the revenue line.
4. Calculate Your Gross Profit
Gross profit is the amount of income left over after subtracting COGS but before subtracting operating expenses. Subtract your COGS from the revenue figure and enter the result as your gross profit.
5. Determine Your Operating Expenses
Operating expenses are the expenses (other than COGS) your business incurs to keep it running, such as wages, rent, office supplies, and more. Operating expenses might be lumped into one section along with cost of goods sold if you use a single-step income statement. However, most businesses use the multi-step income statement format, which shows operating expenses broken out into multiple line items for different types of expenses. You may want to group certain operating expenses on one line for simplicity's sake. For example, your electric, gas, and sewer utility expense can be grouped as “Utilities." This keeps your income statement from becoming too unwieldy.
Enter each operating expense grouping on your income statement under the Operating Expenses subhead, with total operating expenses on a line beneath.
6. Calculate Your Net Income or Loss
Subtract your total operating expenses from your gross profit and enter the result on the final line of your income statement. You have net income if the total is a positive amount. You have a net loss if the result is a negative amount.
Income Statement FAQs
If you're new to preparing an income statement, you may have a lot of questions about the process. Here are answers to some of the most frequently asked income statement questions.
What Is a Single-Step Income Statement?
A single-step income statement lists all expenses, including cost of goods sold, in one column. This format may be acceptable for sole proprietors and very small businesses. However, most companies issue multi-step income statements, which break out cost of goods sold, gross profit, and operating expenses.
What Is Included in an Income Statement?
An income statement typically includes revenue or sales, cost of goods sold, gross profits, operating expenses, and net income or loss.
What Is the Basic Format of 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. If expenses are greater than revenues, the company is operating at a loss and needs to generate more revenues or reduce expenses.
What's the Easiest Way to Prepare an Income Statement?
Thanks to modern accounting software, the days of keeping track of revenues and expenses in a physical ledger and manually creating an income statement are over. These days, businesses have many affordable options for cloud-based accounting software that can record all transactions and generate a balance sheet, income statement, and statement of cash flows within minutes.
Your income statement must be accurate to be useful for assessing your business's performance and making decisions. If you need help with bookkeeping and preparing financial statements, it's a good idea to work with a professional.