What’s an income statement?

An income statement is a document that reports the overall financial picture of a business by calculating income and expenditures together. It summarizes a business’s revenue and expenses to provide an idea of a business’s financial health. It’s usually created by an accountant and may also be referred to as a profit and loss statement or a statement of revenue and expense.

Income statement vs. balance sheet vs. cash flow statement

An income statement is one of three important documents that help indicate a business’s financial health. It’s important to not confuse income statements with balance sheets, which details a business’s assets or liabilities, or a cash flow sheet, which monitors current income and expenditures.

Why are income statements important?

Income statements are crucial to understanding and analyzing the overall profitability and health of a business. As a business grows, its expenses usually also grow. This might include expenditures like rent, wages, advertising and supplies. An income statement is prepared quarterly or monthly, providing a frequent overview of a business’s financial health so rising expenditures can be quickly identified. This has both external and internal uses.

Internal use

Internal users, such as business owners, accountants and management can use the information from income statements to analyze and strategize business operations. Internal users can identify and analyze where certain profits and expenses are sourced and use that information to create more efficient business strategies. Businesses can compare income statements month over month or quarter over quarter to analyze trends in business financial activity.

External use

External users include investors, creditors and competitors. Investors use income statements to determine if the business has a high profit likelihood and if it’s worth investing in, and creditors use income to ensure that a business will be able to manage any loans that it’s given. Competitors use income statements to analyze industry trends, successes and strategies.

Components of an income statement

What does an income statement show? Formats of income statements may vary according to local regulations, but they generally contain the same components. The various components of an income statement serve to show a diverse picture of a business’s financial health and profitability.

Operating revenue

Operating revenue or sales refers to revenue gained through activities such as the sale of a product or service. For a business that sells retail goods, for example, a sale of a product would be accounted for in the overall operating revenue for that income report. Compared to net income, operating revenue is typically a better indicator for business performance as it expresses a business’s profits before costs and taxes.

Non-operating revenue

Non-operating revenue refers to income acquired through non-operating business activities. In other words, this means that this is revenue sourced outside of the sale of services or goods. This may include rental income, royalty payments or interest gained from business capital.

Cost of goods sold (COGS)

COGS may include the cost of goods, products or services sold. For a manufacturer, for example, the cost of sales is derived from the expenses of manufacturing materials and labor.

Gross profit

Gross profit, sometimes called gross income, revenue or margin, shows the difference between net sales and the cost of goods sold. It may consider variable costs that fluctuate with levels of business activity.

Gains

Gains refers to activity that causes a business’s income to increase. Gains differ from revenue in that gains, while considered a form of secondary revenue, refer to the sale and profits of a business’s fixed assets. This may include the sale of vehicles, property or other assets that the business owns.

Expenses

Expenses refer to the cost for a business to operate and profit. They may include operating expenses that are incurred by a business’s main business activities, such as sales commission and supplier payments. Expenses that are not part of a business’s main activities are non-operating expenses, which may include legal expenses or product loss.

Advertising expenses

Advertising expenses are those that a business incurs in an effort to promote itself. This might include outbound marketing or print and media advertising. Advertising expenses are usually necessary to grow a business.

Administrative expenses

Administrative expenses are another type of operational expense that might also be referred to as Sales, General and Administrative (SG&A) expenses. It’s sometimes a useful indicator of business management efficiency as it includes expenses such as salaries, rent and office supplies.

Depreciation

Long-term assets owned by a business may depreciate in value over time. Management will distribute the cost of an asset over its lifespan to show the asset value used by the business over time.

Income taxes

Income taxes included on income statements don’t necessarily represent the amount of tax a business actually paid, but instead, they provide an estimate as to how much the business expects to pay.

Earnings before tax (EBT)

EBT measures a business’s financial health and profitability. It subtracts expenses from income before taxes are applied.

Net income

Net income refers to the bottom line of a business’s income after deducting business expenses and is often used to indicate a business’s profitability. It’s calculated by subtracting total expenses from total revenue. The goal of a business is to keep this amount positive because a negative amount indicates that expenses have exceeded income and then business is not profitable. While gross profit is revenue earned after deducting COGS, net income is the overall earning after deducting all expenses.

Income statement examples

Income statements usually are formatted as either single-step or multi-step income statements. Let’s take a look at an income state example for both.

Single-step income statement

A single-step income state is a simple income statement that simply totals income and expenses to arrive at a net income calculation. A single-step income follows this formula:

Net income = (revenue + gains) – (expenses + losses)

This single-step income statement example shows the first quarter of a retail business:

This example shows that the business earned a total revenue of $35,000, paid $11,500 in expenses, made $50,000 in gains and lost $1,000. If we input this number in the single-step formula, we are given the amount of $85,000 as a net income.

Multi-Step income statement

A multi-step income statement provides a more complex view of a business’s financial health and activities. This format is used by many larger businesses because they often have more complex financial activities and more demanding reporting regulations. It separates operating revenues, operating expenses and gains from non-operating expenses, non-operating revenues and losses.

This multi-step income statement example uses the same data as the previous example but with a different format: