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An income statement, also known as a profit and loss statement (or P&L), summarizes your company’s financial transactions. It shows you how much you earned and how much you spent for a specific reporting period, which may be one month, one quarter, or one year.
An income statement is an important tool for any business owner because it lets you know whether your business made a profit or took a loss during the period being reported. It also helps evaluate past performance, predict future performance, and determine if changes need to be made.
Read on to learn what goes on an income statement, how to read an income statement, and how they can help you grow your business.
Key Points
• An income statement summarizes a business’s revenues, expenses, and profits over a specific period, providing insights into operational performance and profitability.
• It typically includes revenue, expenses, gross profit, operating income, and net income.
• Businesses can choose a single-step format, which simplifies calculations, or a multi-step format, which offers detailed breakdowns like gross and operating income.
• Public companies must prepare income statements in compliance with accounting standards like GAAP or IFRS, ensuring consistency and comparability.
• Income statements can be used to boost profits or help the company grow, especially if the business needs to take out a small business loan.
What Is an Income Statement?
An income statement shows your company’s income and expenditures. It also indicates whether your company is making profit or taking a loss for a given period, which could be one month or one quarter.
An income statement is one of three key financial statements that help you understand the financial health of your business. The other two are the balance sheet and cash flow statement.
One way to think about a balance sheet vs. an income statement is that a balance sheet tells you where you are right now, whereas an income statement tells you how you got there.
A single-step income statement displays a company’s revenue, expenses, gains (income from other sources), and losses (one-time or unusual costs) to arrive at its net income. The equation is a simple one:
Net Income = (Total Revenue + Gains) – (Total Expenses + Losses)
Large corporations that have multiple business segments offering a mix of products and services will typically use a multi-step income statement. Multi-step statements, which separate operating and non-operating revenues and expenses, may also include gross profit, earnings before tax, taxes paid, and net profit.
How To Read an Income Statement
An income statement consists of different line items. Each line item is a category (such as “expenses”) that may be further broken down into smaller categories (such as “wages” or “rent”).
As you read through an income statement, you follow a linear path from the “top line” (the total money you’ve made before any expenses are taken into account) to the “bottom line” (the actual profit you earned). Along the way, you see how the top line amount gets whittled down as the money is used to pay for the cost of creating your products or services and keeping your company running.
Many business owners focus exclusively on the bottom line — their net profit — but it can also be important to look at your sales revenue. Often, there’s only so much you can do to improve your bottom line by cutting expenses. At a certain point, you may also need to increase your revenue in order to grow your business.
Key Components of an Income Statement
What goes on an income statement will depend on the type of business you own. However, the following categories are often included in an income statement.
Revenue
Sales revenue is how much money the company made from sales or services within a given time period. If your company has multiple revenue streams, each will be a line item under the “revenue” category of the income statement.
For some businesses, revenue needs to be further broken down into “operating” (revenue from the business’s core activity, such as selling a product) and “non-operating” (revenue generated from other activities, such as installing or maintaining the product it sells).
You may need to factor in gains as well. Gains are a specific type of non-operating income (aka “other income”). They generally result from an event that has nothing to do with the company’s primary source of income. Gains may include selling of assets, lawsuit settlements, or investments in financial instruments.
Expenses
One major expense is the cost of goods sold, or COGS. This figure is based on how much you pay to create your products, and includes only costs directly associated with those sales. For example, costs associated with goods may include labor, parts, and materials.
If the company is a service business, this line item may be called cost of sales, and includes the cost of paying wages and providing the supplies you need to perform those services.
In addition to the COGS, you also want to include expenses that are not directly associated with your core business, such as administrative costs (e.g., rent and utilities), marketing and advertising, interest paid on a loan, and research and development expenses.
Depreciation is another expense that may also be included if you spent a large amount on an essential piece of equipment and you’re depreciating part of its value every accounting period.
Tracking and categorizing expenses as you go will make compiling this part of your income statement much easier.
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Gross Profit
Gross profit is sometimes included in an income statement and is calculated by subtracting the COGS (or cost of sales) from total sales revenue during the statement period. Gross profit doesn’t take into account general business expenses, interest payments on loans, or income tax.
Operating Income
Once you calculate gross profit, you can subtract selling, general, and administrative expenses to calculate operating income. This amount represents the working capital available to the business after all expenses are paid. Operating income tells you how much your business made after subtracting all internal costs (which you can control) but before paying external expenses.
Net Income
A company’s net income (aka net profit) is the “bottom line” of an income sheet. It’s calculated by subtracting total expenses, including interest charges and taxes, from total revenue. Net income tells you what your company actually earned (or lost) during the accounting period.
What Are Income Statements Used For?
Income statements show a company’s sales, gains, losses, and overall profit or loss during a certain period. This information can be used to make financial projections. For example, if income statements show a 10% increase in sales year over year, it suggests the company can expect continued growth the following year. It’s not a guarantee, but a reasonable expectation.
This information can also be used to help business owners decide whether they can boost profits by increasing revenues, decreasing costs, or both. They can then refer to later income statements to see if the strategies have paid off.
Below are some other ways in which an income statement can be useful for a small business.
Frequent Reports
Unlike many other financial statements, which are done annually, income statements are typically generated quarterly or monthly. As a result, they can be more helpful in tracking business performance. Because of their frequency, income statements allow owners to pick up on small issues before they snowball into larger, and potentially more expensive, problems.
Pinpointing Expenses
When a company has a large number of expenses, it can be easy to lose track of where all of the money is going. An income statement analysis shows owners if expenses are on, over, or under budget and also highlights unexpected expenses. The statement could reveal ways for the company to upgrade or streamline operations, possibly with a small business loan. This could help decrease costs and, in turn, improve net income.
Analysis of the Business
A company seeking an infusion of funds, from either an outside investor or a lender, will need to show how it’s performing financially. For example, when applying for a business loan, you will typically need to provide your income statements.
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Limitations in Income Statements
Income statements are useful but they have their limitations. The biggest limitation in income statements is reliance on assumptions. Companies may assume an asset is going to depreciate less than it actually does, or they may predict how many products will be returned in a given quarter. More than likely, both of these projections will not be exact, which causes the income statement to be flawed.
Getting the assumptions wrong can be extra perilous for pro forma income statements, which rely on specific expectations or hypotheticals to project a company’s future income, expenses, and profitability.
On a smaller scale, inaccurate assumptions can also cause problems on budgeted income statements. A budgeted income statement, used to forecast business activity in the near term, relies more on current information than on assumptions. But it does call for projections of future expenses, revenues, and profit, any of which may be incorrect.
Other limitations in income statements include being time-consuming to prepare and inaccurately reflecting how well (or poorly) a company is performing. However, overall, income statements can provide a good summary of the company’s financial health.
Income Statement Example
Below is an example of a simple, single-step income statement for a small business.
| REVENUE | |
|---|---|
| $40,000 | Merchandise sales |
| $10,000 | Revenue from installation |
| $50,000 | Total revenue |
| EXPENSES | |
| $20,000 | Materials |
| $800 | Wages |
| $2,500 | Rent |
| $225 | Utilities |
| $450 | Advertising costs |
| $350 | Administrative costs |
| $24,325 | Total expenses |
| GAINS | |
| $1,500 | Income from vehicle sale |
| LOSSES | |
| $1,500 | Lawsuit |
It may be worthwhile tracking down income statement examples from companies similar to yours to see how all the sections fit together.
GAAP Income Statements
U.S. public companies report their earnings on income sheets based on GAAP, or generally accepted accounting principles. GAAP is a standardized set of rules, which allows investors to analyze and compare companies’ statements against one another objectively.
GAAP income statements consist of several different business financial statements, including the balance sheet, the statement of owner’s equity, and the cash flow statement. This provides a detailed look at a company’s revenue and expenses, and it standardizes how the information is presented to creditors and shareholders.
One type of income statement that’s not recognized under GAAP is the variable costing income statement. Although GAAP financial reports do not include variable costing, business owners often use this method to calculate how many units need to be sold before the company starts earning a profit.
The Takeaway
An income statement is a key source of information about many factors that affect a company’s profitability. It shows a company’s expenses, income, gains, and losses; that information goes into a mathematical equation to arrive at the net profit or loss for the given time period.
An income statement helps business owners decide whether they can boost profits by increasing revenues, decreasing costs, or both. Being able to see this information at short intervals can help business owners make timely decisions.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
Is there a special format for income statements?
Income statements follow no universal format but typically include three sections: revenue, expenses, and net income. Businesses can use single-step or multi-step formats, with the latter providing detailed breakdowns like gross profit and operating income, offering greater insight into financial performance.
What is an income statement’s most important part?
The most important part of an income statement is the bottom line — net income. This tells you exactly how much your business is making, after expenses.
What is the difference between a balance sheet and an income statement?
A balance sheet is a record of your company’s current debts, assets, and equity. An income statement tracks a company’s income and expenditures over a certain period of time and shows overall profit or loss during that period.
What are some common errors in interpreting income statements?
Common mistakes include ignoring explanatory notes, overlooking the company’s cash flow, misinterpreting measures of profitability, neglecting accounting changes, and focusing too much on short-term results. Explanatory notes give context and additional details that clarify the numbers. Changes in accounting policies can distort year-over-year comparisons, as can random factors that may have impacted short-term results.
How often should income statements be reviewed for small businesses?
The U.S. Chamber of Commerce recommends business owners review their income statements monthly. Regularly monitoring expenses and revenue can reveal the impact of even small operational changes.
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