Income statements provide business owners with a clear picture of financial performance. Learn about the different income statement formats and choose the one that best suits your business.
An income statement, also known as a profit and loss account, provides detailed information about business income and expenses for a given accounting period.
Important to business owners, financial institutions, and investors, an income statement clearly shows whether a business is making a profit.
Presentation: what is an income statement?
If you want to know how profitable your business is, create an income statement. An income statement lets you know exactly how much profit (or loss) your business has generated during a particular accounting period after all income and expenses have been accounted for.
There are several variations of income statements, which we will explore later. We’ll also provide step-by-step instructions for creating an income statement for your business.
Income statement vs balance sheet: what is the difference?
An income statement provides details of income, sales, and expenses for a specific period of time. Information such as sales, cost of goods sold, and operating expenses are all included in an income statement, which reports net income for the period and provides a good overview of business performance.
An income statement is designed to report income and expenses for a specific period of time.
A balance sheet accounts for the assets, liabilities and owner’s equity of your business. Assets are things you own, such as cash, bank accounts, accounts receivable, and inventory. Liabilities are things you owe, including accounts payable, taxes, and loans.
Finally, owner’s equity is the amount of money currently invested in the business and includes retained earnings. Unlike an income statement, a balance sheet reports the assets, liabilities, and equity of the business as of a specific date, not a specific period.
A balance sheet is used when calculating accounting ratios to determine if the business has enough assets to pay its debts.
Four types of income statements
There are many variations of tax returns that you can run. Here are some of the most commonly used types of tax returns:
1. One-step income statement
The single-step income statement is the simplest income statement format. It calculates income totals and subtracts expenses to arrive at net income. The easiest income statement to prepare, the one-step income statement provides an overview of income and expenses at a glance.
While it’s not for everyone, most small business owners will find the one-step income statement sufficient.
2. Multi-step income statement
The multi-step income statement provides more detailed information about your company’s financial performance. break down revenues and expenses into operating and non-operating categories. The multi-step income statement is completed using a three-step calculation:
- Gross profit: The first step is to calculate gross profit or gross margin. This is done by subtracting the cost of goods sold from the net sales.
- Operating profit: Next, you will calculate operating profit by subtracting current operating expenses from gross profit, which was calculated in Step 1.
- Net income: Finally, you will calculate your net income by adding or subtracting other income and expenses from your operating income.
If your business is growing or you are planning to apply for a bank loan, the multi-step income statement is a better choice, as it provides details such as gross profit and operating income that are missing in the income statement. result in one step.
3. Common Size Income Statement
Used strictly for analytical purposes, the common size income statement, called vertical analysis, expresses the total of each line item as a percentage of sales.
Extremely useful for comparing a company’s performance from year to year, the standard size income statement is also used by investors to spot trends in the company that may not be easily visible on an account. standard result.
4. Contribution income statement
The contribution format income statement, also known as the variable cost income statement, deducts all variable expenses from revenues to arrive at a contribution margin.
Fixed expenses are then subtracted from the contribution margin to arrive at your net profit or net loss for the period. Useful in a manufacturing context, the variable cost contribution/income statement format provides details about variable costs that a standard income statement does not provide.
Aside from formatting, the net income or net loss will remain the same regardless of the type of income statement used.
How to prepare an income statement for your small business
If you are a small business owner using accounting software, your income statement will be created for you. But even if you don’t prepare financial statements manually, you still need to know what the process is for creating an income statement. Follow these steps to create an income statement in one step.
Step 1: Determine your accounting period
Determine the time period you want your income statement to reflect. The statement above is for the month of May 2020, so it will include all income and expenses incurred throughout the month of May.
Step 2: Run a trial balance
The trial balance provides you with period-end totals for all your general ledger accounts. You will need to use these amounts to calculate the totals reflected in your income statement.
Step 3: Calculate total revenue
Add up all your income for the month of May. For example, you received payment for the following amounts:
- $1,200 for copy and print services on 5-2-2020
- $5,000 for office staff on 5-11-2020
- $3,500 for administrative services on 18-5-2020
- $4,000 for office staffing on 05/27/2020
- $1,300 for printing on 5-31-2020
- $500 for the rental of a small office on 31-5-2020
After calculating the revenue, you will end up with $15,000 of sales revenue and $500 of other revenue that will go to the income statement.
Step 4: Calculate expenses
Since you are preparing an income statement in one step, you can consolidate all expenses into one section. If you prepared a multi-step income statement, you would separate your cost of goods sold to calculate gross income or gross margin, from which your other operating expenses would be deducted.
Using your trial balance, find your monthly expenses that should be included in the income statement. Here are the expenses incurred:
- $4,500 for salaries
- $400 for copier ink
- $600 for paper
- $1,000 for the rental of the building
- $175 for the electricity bill
- $125 for gas bill
- $175 for a CPA consultation
- $1,000 for taxes
These expenses should be placed in the correct categories on your income statement and added up for the total expenses.
Step 5: Calculate net income
Now that your income and expenses are recorded on your income statement, you can complete the final step, which is to subtract your expenses from your income to arrive at net income. Looking at the income statement above, here is your calculation:
$15,500 – $8,575 = $6,925
This means that for the month of May, your net income was $6,925
Choose the income statement format that suits you best
Freelancers, sole proprietors, and consultants will find the one-step income statement works well for their needs, while larger or growing businesses will likely use the more comprehensive multi-step income statement.
If you currently manufacture goods, the contribution or variable cost format will provide a clearer picture of financial performance, while businesses that want to analyze business performance in more depth can create a common-size income statement. .
Whichever income statement format you choose, the best way to produce an accurate financial statement of any kind is to use accounting software.
If you’re still struggling with multiple accounting books, be sure to check out The Ascent’s accounting software reviews and be prepared to leave those books behind.