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Income Statement in Business: What It Is and Why It’s Important

Income Statement in Business: What It Is and Why It’s Important
Lauren Ward
Lauren WardUpdated March 16, 2022
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An income statement, also known as a profit and loss statement (or P&L), summarizes your company’s financial transactions, then shows you how much you earned and how much you spent for a specific reporting period. An income statement is an important tool for any business owner because it lets you know whether your business made a profit or lost money during the period being reported. It also helps you 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 prepare an income statement, and how they can help you grow your business.

What Is an Income Statement?

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.An income statement shows you your company’s income and expenditures, as well as if your company is making profit or loss for a given period, which could be one month or one quarter. 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 simple, 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 a simple equation: 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, which separates operating and nonoperating revenues and expenses, and may also include gross profit, earnings before tax, taxes paid, and net profit.

Understanding and Reading an Income Statement

An income statement is broken down into different line items. Each line item is a category (such as “expenses”), that may be further broken down into small categories (such as “wages,” “rent,” etc.).As you read down 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,” which is the actual profit you earned. Along the way, you see how the top line amount gets whittled down as it’s used to pay for the cost of creating your products or services and keeping your company running.While a lot of business owners focus exclusively on the bottom line — their net profit, 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.

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 to 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 these 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 done quarterly, or sometimes even monthly. As a result, they can be very 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 expensive, problems. 

Pinpointing Expenses

When a company has a lot 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.

Analysis of the Business

A company seeking an infusion of funds, either from 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. Recommended: Understanding Different Types of Small Business Loans

What to Include in an Income Statement

What goes on an income statement will depend on the type of business you own. But here are some categories that are often included on an income statement.

Revenue of Sales

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 “nonoperating” (revenue generated from other activities, such as installing or maintaining the product it sells). 

Gains

Also known as “other income,” gains are the result of an event that causes the company’s income to increase but has nothing to do with the company’s primary source of income. Gains may include:
  • Selling of assets
  • Lawsuits
  • Investments in financial instruments

Cost of Goods Sold

Also referred to as COGS, this is how much you pay to create your products. It only includes costs directly associated with those sales. For example, costs associated with goods may include labor, parts, and materials. Depreciation 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. If the company is a service business, this line item may be called Cost of Sales, and include the cost of paying wages and providing the supplies you need to perform those services.

Gross Profit

Gross profit margin is sometimes included in an income statement and is calculated by subtracting the cost of 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.

Expenses

In addition to the COGS, you also want to include expenses that are not directly associated with your core business, such as marketing, rent, utilities, interest paid on a loan, general and administrative expenses, and research and development expenses. Tracking and categorizing expenses as you go will make creating this part of your income statement much easier. Recommended: 5 Small Business Tax Tips for Business Owners 

Advertising Costs

This is one of the line items you will want to list under “Expenses” (above), and includes any costs associated with expanding your client base, such as marketing, promotion, social media, and advertising.

Administrative Costs

Administrative costs is often another line item under “Expenses.” These are costs that are unaffected by sales, and generally stay the same year to year. Administrative costs can include such things as salaries for employees, rent, utilities, and office supplies. 

Net Income

A company’s net income is the “bottom line” of an income statement  and is calculated by subtracting total expenses from total revenue. Net income tells you what your company actually earned (or lost) during the accounting period.

Earnings Before Tax

While not present on all income statements, earnings before tax (also known as EBT or pre-tax income) is calculated by subtracting expenses from a company’s total income before tax. It is sometimes included in a multi-step income statement.

Depreciation

Depreciation may be included as a line item on an income statement. It refers to the process of deducting a large business asset’s cost as a business expense over the period of its useful life. Rather than deducting the full cost of the asset in full as a one-time expense, the cost is spread out over a period of time. 

Income Statement Example

Below is an example of a simple, single-step income statement for a small business.

The Takeaway

An income statement is a key source of information about factors responsible for a company’s profitability. It shows a company’s expenses, income, gains, and losses, which are then put into a mathematical equation to arrive at the net profit or loss for that time period (which might be a month or one quarter). An income statement helps business owners decide whether they can boost profits by increasing revenues, decreasing costs, or both. Due to the frequency of these statements, they can help you make timely decisions that can help your company grow. For example, you might decide to seek out a business loan so that you can upgrade or streamline operations. This could help you decrease costs and, in turn, improve your net income, or so-called “bottom line.”

3 Small Business Loan Tips

  1. Generally, it can be easier for entrepreneurs starting out to qualify for a loan from an online lender than from a traditional lender. Lantern by SoFi’s single application makes it easy to find and compare small business loan offers from multiple lenders.
  2. SBA loans are guaranteed by the U.S. Small Business Administration and typically offer favorable terms. They can also have more complicated applications and requirements than non-SBA business loans.
  3. If you need to borrow money to cover seasonal cash flow fluctuations, a business line of credit, rather than a term loan, provides the flexibility you likely need.

Photo credit: iStock/LumiNolaThe tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice. SOLC0122026

Frequently Asked Questions

Is there a special format for income statements?
Is there a most important part of an income statement?
What is the difference between a balance sheet and an income statement?

About the Author

Lauren Ward

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.
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