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Guide to Income Statements in Business

Income Statement in Business: What It Is and Why It’s Important
Lauren Ward
Lauren WardUpdated September 28, 2023
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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 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.Recommended: How to Calculate Cash Flow (Formula & Examples)

Understanding and Reading 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 down an income statement, you follow a linear path from the “top line,” or 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 many 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.Recommended: Understanding Pro Forma Income Statements

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. Luckily, small business financial software can help make keeping track of revenue and expenses easier and more streamlined.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 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.

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

Limitations in Income Statements

Income statements are not perfect, and there are limitations when it comes to them. The biggest limitation in income statements is making assumptions. Companies may assume an asset is going to depreciate less than it actually does, or they may predict how many returns will be made in a given quarter. More than likely, both of these figures will not be exact, which causes the income statement to be off.Other limitations in income statements include them being time consuming to prepare and them not accurately reflecting how well (or poor) a company is performing. However, overall, income statements provide a good basis to the company’s financial health.

10 Things to Include in 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 on an income statement.

1. 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). 

2. 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

3. 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.

4. Gross Profit

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

5. 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 

6. Advertising Costs

Advertising costs are an expense, and they include any costs associated with expanding your client base, such as marketing, promotion, social media, and advertising.

7. Administrative Costs

Administrative costs are often another line item under the “expense” category. 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. 

8. 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.

9. 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.

10. 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.
REVENUE
$40,000Merchandise sales
10,000Revenue from installation
50,000Total revenue
EXPENSES
$20,000Materials
800Wages
2,500Rent
225Utilities
450Advertising costs
350Administrative costs
24,325TOTAL EXPENSES
GAINS
$1,500Income from vehicle sale
LOSSES
$1,500Lawsuit

Building an Income Statement

When building an income statement, the first thing you want to do is determine your reporting period, whether that’s one month, one quarter, or one year. From there, calculate your total revenue during that time period.Next, calculate your expenses. This includes what you spent on labor, materials, operating expenses, supplies, and more. Subtract your expenses from your revenue. This is called your gross profit, or earnings before interest and taxes.Finally, calculate any interest charges and taxes. Subtract this from your gross profit, and you have your net income.Recommended: 9 Steps for Small Business Accounting Success

GAAP Income Statements

GAAP, or Generally Accepted Accounting Principles, income statements are how U.S. public companies report their earnings. It’s a standardized set of rules, which allows for investors to analyze and compare company’s earnings 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 standardizes how the information is presented to creditors and shareholders.

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 one 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 businesses make timely decisions that can help the company grow. For example, the business owner might decide to seek out a business loan in order to upgrade or streamline operations. This could help decrease costs and, in turn, improve net income.

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.

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?
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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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