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Understanding an Income Statement

Financial reporting is a central element to running a business — you can’t get very far without eventually realizing you need to organize your financials for business purposes or even for taxes.

Good financial management requires you to maintain detailed financial records. The three most important financials your (public) business is required to have is the income statement, balance sheet and statement of cash flows. These statements are used to provide a glimpse into the financial health of the business.

Read on to get familiar with one of the most essential financial reports for your business, the income statement, which provides a solid snapshot of the financial ins and outs of your business.

What is an income statement?

An income statement shows the details of your business’s revenues and expenses — what is coming in and going out over a certain period of time, usually a quarter or a year. The income statement is sometimes called a profit and loss statement (P&L) statement because it’s used to calculate the net profit and loss during that period.

The income statement is one of the key financial documents that public companies must report to the U.S. Securities and Exchange Commission (SEC) annually (along with a balance sheet, cash flow statement, and statement of stockholders’ equity). The IRS also requires an income statement in order to accurately assess taxes, so pretty much every business in the U.S. has to create an income statement, even sole proprietors, who submit a Schedule C.

Income statements reveal many things about your business, including your company’s year-over-year (YOY) and quarter-over-quarter (QOQ) performance. These statements often include two or three years of data to show trends and can be used to determine your company’s return on equity (ROE), return on assets (ROA), gross profit, operating profit, earnings before interest and taxes (EBIT), and earnings before interest taxes and amortization (EBITDA).

An income statement helps all interested parties discern the financial health of your business and identify any trends in those numbers. Investors and tax assessors like these statements because they provide a lot of useful data about your business. However, these statements can also help you make financially sound decisions to ensure your business is moving in the right direction.

How to prepare an income statement

There is no single one-size-fits-all income statement format required by law. The business purpose of the income statement is to detail the company’s financial health, so the format of the document can vary depending on the business.

You can create an income statement from scratch using a spreadsheet program like Excel or use one of the many templates that are available online. These statements usually include lines for revenue, tax expenses, profit or loss, and comprehensive income, among other things. You can categorize expenses in any way you choose, but it’s recommended that you have a row for every distinct cost type.

What’s on an income statement?

While not all income statements list exactly the same information, there are some line items commonly found on these statements. Make sure to include at the least the following when preparing your own statement:

  • Revenue: The amount of money that a company brings in during a particular time period, which includes any discounts and returns.
  • Taxes: Income tax costs are considered part of a business’s non-operating expenses and are captured on the income statement.
  • Profit before tax (PBT): The profits (revenue minus expenses) a company makes before paying corporate income tax.
  • Expenses: Goods, services or other items that the company spent money on during the reported period.
  • Depreciation expense: The loss of value accrued by a company’s long-term noncash assets during the reported time period.
  • Employee benefits expense: Employee benefits such as wages and salaries, pension costs, stock option costs and other benefit costs.
  • Research and development (R&D): The costs of research and development of new products, recorded as an operational expense.
  • Administrative expenses: Costs related to the daily operations of the business, such as rent, insurance, office supplies, subscriptions, and utilities.
  • Cost of sales: Otherwise known as Cost of Goods Sold (COGS), this is the cost of merchandise the company sold in the reported period.

 

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How to prepare an income statement:

  1. Supply standard info (such as company name, period, date, etc.)
  2. Determine net sales
  3. Determine cost of sales or goods sold (this can get really complex, so try to keep it as simplified as possible)
  4. Determine gross margin (minus unsold inventory)
  5. Determine administrative and other expenses
  6. Determine net operating profit
  7. Determine any outlying expenses or income
  8. Determine net profit before income taxes
  9. Conclude by calculating your net profit

Income statement: Operating vs. non-operating

Income statements are typically divided into operating and non-operating revenue and expenses. Operating revenue and expenses are those that are related to primary business activities (such as making and selling goods and services), whereas non-operating revenue and expenses are not related to primary business activities, but still affect the company’s bottom line.

To clarify, the general rule is that a non-operating revenue or expense is any activity that is not related to making or selling a company’s products or services, but has an influence on the business income.

Examples of operating vs. non-operating expenses
Non-operating Expenses Operating Expenses
Revenues from non-primary business activities Cost of Goods Sold (COGS)
Expenses or losses unrelated to primary business activities Selling, General, and Administrative Expenses (SG&A)
Gains that are uncommon or infrequent Depreciation and amortization
Finance costs, such as interest expense for borrowing Research & Development (R&D)
Income tax expenses

 

Income statement templates

Starting with a template is the easiest way to create an income statement, and there are many good options to choose from online. These free options — all Excel templates — will help you create a well-formatted statement in no time.

  • Microsoft Office Template 1: A 12-month template that you can edit in your browser with tabs that differentiate revenue and expenses, and a line graph for an appealing visual.
  • Microsoft Office Template 2: A simpler option is this straightforward plug-and-play template that allows you to set the appropriate time period for your data.
  • QuickBooks Template: A fully customizable template that provides a completed example to guide you.
  • SBA Template: A one-page, one-year statement that includes suggested expense categories.

The bottom line

In the world of business, it is essential to be familiar with the process of creating an income statement. Sooner or later you’ll need to put together this key resource, whether for investors or the IRS.

Maintaining good financial records from the very beginning is the best course of action, so you aren’t scrambling to make sense of everything when it’s needed. the income statement is useful for your own perspective, allowing you to quickly see how your business is doing and make any changes as needed.

 

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