Guide to Income Statement Prep

Q: What are the 4 parts of an income statement?

The four main elements of an income statement are: Revenue Expenses Gains Losses

Q: How are income statements and balance sheets different and similar?

Balance sheets and income statements both offer insights into a company’s performance and potential for growth, but there are some key differences. A balance sheet provides a snapshot of a company’s financial position at a specific point in time. It includes what the company owns (its assets), what it owes (its liabilities), and owner’s equity (which includes money initially invested in the company plus any retained earnings). An income statement, on the other hand, measures a company’s performance over a period of time. It includes sales revenues, expenses, gains, and losses for the reporting period and tells you whether the company made a net profit or loss during that period.

Lauren WardUpdated April 12, 2023

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The income statement is one of the three key financial statements issued by businesses, along with the balance sheet and cash flow statement. Also known as the profit and loss statement, the income statement shows what your company earns, what it spends, and if it’s making a profit or operating at a loss.Preparing an income statement for your small business can help you determine its current financial health. It can also help you pinpoint future opportunities for growth and set achievable goals for your team. Fortunately, you don’t need a background in finance or a degree in accounting to prepare and analyze an income statement. Here’s what you need to know about these important financial reports — including what they are, what they include, and what you can learn from them.

What Is an Income Statement?

An income statement details a company’s income and expenses over a specific period, such a month, quarter, or year. It’s one of the most important financial statements because it provides a holistic view of a company’s financial health, including revenue, expenses, losses, and profits. You’ll need an income statement for both internal decision making and external deals, such as bringing in an investor or getting a small business loan.

What Income Statements Do

Income statements record all revenues and expenses during a certain reporting period. Ultimately, the goal of an income statement is to show a company’s net income for the reporting period, meaning how much did it actually make (or lose) after all expenses and losses are subtracted from sales.Income statements also help you determine if you can boost profits by increasing revenues, decreasing costs, or a combination of both. After analyzing an income statement, you might decide to increase production or shut down a certain product or department. In addition, you can use an income statement to assess whether strategies you set at the beginning of a fiscal period were successful.

Who Uses Income Statements

Publicly traded companies must prepare income statements quarterly and annually to be compliant with the Generally Accepted Accounting Principles (GAAP). However, all companies typically prepare and use income statements. As for the individuals who use these statements, they generally fall into two groups: internal and external. Internal users include business owners, company management, and the board of directors. These internal stakeholders will use an income statement to analyze the company’s financial position and make decisions in order to maximize profits.External users often include investors and creditors. Potential investors will often look at a company’s income statement to assess whether the company is positioned for growth. If you’re in the market for a small business loan, lenders will look at your company’s income statement to determine whether you have enough cash flow to take on additional debt.

Is There a Standard Format for Income Statements?

There are two basic templates a company can use to prepare an income statement: single step and multi-step.The single-step income statement is commonly used by sole proprietors and small-sale businesses. It simply displays the company's expenses and revenues without breaking them down into further subcategories. The multi-step income statement, on the other hand, is generally used by larger companies and publicly traded companies. It breaks down revenues and expenses into operating and non-operating business activities and uses three equations (rather than one) to arrive at net income. A small business can choose whether they want to use a single-step or multi-step income statement.Recommended: Understanding Budgeted Income Statements

Tips on Preparing an Income Statement

What follows is a step-by-step guide to preparing a simple multi-step income statement.

Choose a Reporting Period

Publicly traded companies must prepare financial statements on a quarterly and yearly basis, but small businesses can choose any reporting period they want. A monthly report makes it easier to spot issues and make adjustments that affect the next month’s business activities. A quarterly or annual report, on the other hand, can help you identify trends over time.

Create a Trial Balance Report

To prepare an income statement, you'll need to first create and print out a trial balance, which is a financial report that shows the closing balances of all accounts at the end of the reporting period. Generating a trial balance report is typically easy to do through most types of accounting software.

Calculating Factors

Next, you’ll need to calculate the following amounts.Total Revenue: This is the amount of money your company took in during the reporting period before expenses are accounted for. Also referred to as gross sales or net sales, its the top line on an income statement.Cost of Goods Sold (COGS): This includes all of the costs and expenses directly related to producing and selling your company’s products or services, such as direct labor expenses, materials, components, and distribution costs.Gross Profit: To calculate gross profit for the reporting period, you simply subtract the COGS from total revenue.Operating Expenses (OPEX): These are the indirect costs associated with doing business. They differ from COGS because they’re not directly associated with the process of producing or distributing products or services. They include:

Rent
Utilities
Overhead
Office supplies
Legal fees

Total income (EBIT): To calculate this, you subtract operating expenses from gross profit. The result tells you how much your business earned for the period before taxes. This is also referred to as operating income or earnings before interest and taxes (EBIT) .Interest and Taxes: Interest is the cost of any debt you owe. To calculate this, you’ll need to know how much you owe and what the interest rate is. Your software can likely calculate the interest you owe for the reporting period. Taxes include local, state, and federal taxes, as well as any payroll taxes you owe for the period.

Calculate Net Income

This is your company’s “bottom line” for the reporting period. To calculate it, you subtract interest and then taxes from your total income, or EBIT. The number you get shows your total profit (if it’s a positive number) or loss (if it’s negative) for the reporting period.

Polishing Off Your Income Statement

To complete your income statement, you’ll want to put a header at the top. This should identify the report as an income statement, provide the name of your business, and specify the reporting period it covers.

Income Statement Example

The income statement below is from a fictional small business and is meant to represent one month of financial activity. Company XYZIncome StatementFor Month Ending June 30

Revenue (Gross Sales)	$30,000
COGS	$10,000
Gross Profit	$20,000

Operating Expenses	$5,000
Operating Income	$15,000

Debt interest	($500)
Income Before Taxes (EBIT)	$14,500

Income tax (19.8%):	$2,871

Net Income	$11,629

The Takeaway

An income statement is a key report used to show all revenue and expenses of a company. Whether you’re a sole proprietor or have a large team of employees, knowing how to prepare an income statement can help you better understand the financial state of your business. It can also help you make informed decisions and successfully scale your company. In addition, you’ll need an income statement if you ever want to bring in an investor or seek outside financing.

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Frequently Asked Questions

What are the 4 parts of an income statement?

How are income statements and balance sheets different and similar?

Photo credit: iStock/ArLawKa AungTun

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About the Author

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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