Feeling lost when it comes to understanding your business’s financial health? If you aren’t keeping a close eye on your business numbers, you could miss out on critical information. Without a clear picture of where your business stands, you can quickly run into cash flow surprises, unexpected tax bills, or even struggle to secure funding when you are ready to grow.
That’s where income statements come in. They break down your revenue and expenses in a way that actually makes sense, giving you the clarity you need to make smarter decisions. Looking to grow your business with additional funding? Income statements are vital for securing additional business funding. Not to mention, they are legally required. In this blog, we’ll walk you through the basics, plus an income statement example to help you create one for your business.
What is an income statement?
An income statement, also known as a profit and loss statement, is a financial document that details your company's revenue and costs during a given accounting period. It shows your company's net income – the difference between its net sales revenue and all other expenses – for the specified period.
Your income statement will generally be one of the three key company financial statements you prepare.
Balance sheet vs income statement vs cash flow: what's the difference?
When it comes to understanding your business’s finances, three key statements tell the whole story: the income statement, the balance sheet, and the cash flow statement. But what does each one really mean? Here’s a simple breakdown.
Income statement
An income statement is like a report card for your business during a specific time period. It shows how much money your business earned (that’s your revenue), what it spent (those are your expenses), and whether you ended up making a profit or facing a loss.
Balance sheet
A balance sheet provides a snapshot of your company's financial position at a specific moment. It lists what your business owns (assets), what it owes (liabilities), and what is left over for the owners (equity). A balance sheet can help you see what your business owns and owes at that precise point in time. When comparing balance sheet vs income statement vs cash flow, the balance sheet is the only statement that represents a single point in time rather than a period.
Cash flow statement
While the income statement tracks profitability, the cash flow statement follows the actual movement of money in and out of your business. It helps you see how your cash is generated and spent across operations, investments, and financing.
What is the purpose of an income statement?
An income statement demonstrates your company's performance through financial figures. Wth a thorough income statement analysis, you can see details on how well your divisions bring in revenue. By understanding this information, you may make business decisions such as product expansions or location adjustments to stabilize or grow your company.
Your current and potential investors and shareholders will also generally request to see your income statements. These entities will need a clear picture of your company's finances to decide whether to make an initial investment, continue investing after an initial investment, or sell some or all of their shares.
Your competitors might also look at your income statement to inform their own strategies. You can do the same with your competitors' income statements. Believe it or not, with income statement analysis, you can see if company numbers suggest branching into a new service as a source for additional profit.
For investors
Any interested investors will use your income statement to evaluate your company’s growth potential and see current profitability. They will take a look at revenue trends, operating expenses, and net income to make a decision on whether or not to invest, hold onto any existing shares, or even sell their stake. These documents help them evaluate any return they might receive on their investment and decide if your business aligns with their strategy for growth.
For creditors
When it comes to getting approved for credit, lenders will take a look at your income statement to assess your ability to pay back any loans. They will analyze revenue streams, profit margins, and the overall health of your business to decide your creditworthiness and the best lending terms for your unique business.
For management
Income statements aren't just something for outside parties; they're crucial for your internal management team too. Your team should use your income statement to make smart business decisions. These documents show which parts of your business are thriving and which sections might need some attention. They help you steer resources and attention and help guide your strategic planning.
Types of income statements: Multi step vs single step
Your income statement can be prepared in one of two formats:
Single-step income statement: This format only details one category each for revenue and expenses. While you might be able to work with this format since you're familiar with your company's operations, external entities such as investors won't be able to do much with this format since it doesn't break down expenses by category.
Multi-step income statement: This format breaks down all costs by category, such as depreciation, interest, tax, and operating expenses. The multi step income statement allows for calculating gross profit and operating income as separate figures, providing more detailed insight into your business performance. This format offers a clearer picture of a company’s financial health, making it more useful for external stakeholders.
When comparing a multiple-step income statement vs. single-step, businesses that require detailed financial insights often choose the multi-step income statement.
Figures you'll commonly see on an income statement
Among the figures you'll commonly see on an income statement are:
Sales revenue: This figure describes all the money you earn from selling your products or services.
Cost of goods sold (COGS): This figure entails all expenses – including but not limited to labor, materials, overhead, storage, and the wholesale price of any products resold – spent to create and sell your products and services.
Gross profit: Gross profit is the difference between your sales revenue and your COGS. It differs from gross profit margin, another term often encountered in accounting (and one that you won't have to factor into your income statement).
Rent: This expense is the amount you pay to rent an office space, warehouse, or other physical space. If you rent equipment or other business items, those might fall under equipment or operating expenses instead.
Utility: This expense entails all money spent to keep the power on, water running, and heat and air conditioning running at your physical locations.
Depreciation: All purchased items, including business equipment, lose value over time. The total value lost during the accounting period in question is an expense that should be added to your income statement.
Operating expenses: Operating expenses are arguably the broadest of all income statement expense categories. They include everything from payroll software to employee wages to insurance payments.
Equipment: Any money you spend to rent, maintain, or refurbish your operating equipment falls under this expense category.
Marketing: All money that you spend connecting your brand with potential new customers and clients goes into this category.
Total general expenses: This category is the sum of all previous expenses. You may also see it referred to as direct expenses since all the expenses comprising this category stem from crucial business operations.
Operating earnings: This figure is the difference between your gross profit and your total general expenses.
Interest payments: If you've taken out any loans to fund your business, then you'll have to pay interest on them. This interest is another expense you must include on your income statement.
Total pre-tax earnings: This figure is the difference between your operating earnings and your interest expenses.
Income tax payments: This figure is the amount your company has paid in income tax during the accounting period in question. It does not include taxes you have withheld from your employees' paychecks – just taxes your company pays directly.
Net income: Subtract your income tax expenses from your total pre-tax earnings to calculate this figure, which is the single most important number on your income statement. This number shows your profitability (or lack thereof) to investors, lenders, and anyone else who might want to see it.
How to prepare an income statement
Creating your income statement may seem challenging at first, but it doesn't have to be if you use the above income statement example as a template. With this template and thorough company bookkeeping and accounting practices, you should face few challenges when creating an income statement – an important document to share with any lenders you approach for funding.
Here are some straightforward steps to follow:
- Gather Financial Data – Collect revenue and expense records for the accounting period.
- Categorize Revenues and Expenses – Organize income and expenses under appropriate headings
- Calculate Key Figures – Determine gross profit, operating earnings, and net income.
- Choose a Format – Decide between a multi-step income statement vs single-step income statement based on your business needs.
- Review for Accuracy – Ensure all figures align with your balance sheet vs. income statement vs. cash flow statement.
Remember that accurate financial record-keeping throughout the year simplifies income statement preparation. Many small business accounting software programs can generate these statements automatically based on your entered financial data.
