What is an Income Statement?
An income statement is important because it shows the company’s income and expenses. It shows whether your company is making a profit or if it has a loss for the given period of time. Income statements convey the profitability of the company.
Components of an Income Statement
When using an income statement, you will want to make sure all the major components are included. This type of financial statement will help you get a good overall picture of your business performance. Most income statements will include the following things:
- Revenue or sales. This is usually the beginning of an income statement. It will show you the gross sales made by the company. Usually, there are two types of revenue. One is operating and the other is non-operating. Operating revenue is when revenue is gained by performing business activities such as making products and providing services. Non-operating revenue is when a non-main business activity is done, like maintaining a system or installing a new one.
- Costs of goods sold. This will be your total cost of sales and services. It includes the cost of the products you sold, not costs such as overhead or other indirect costs.
- Gross profit. This is your sales minus the total cost of goods sold in the business. Keep in mind that sales is the amount of money you received from selling the product, while the cost of goods sold is the money you spent to make the product.
- Gains. They appear when the company’s other income has increased. Gains occur through selling a fixed asset rather than the money you earned from selling products. The gains of a business owner might be the money made from selling land or old company vehicles that are no longer in use.
- Expenses. These are costs you have in order to make revenue. This can be anything from supplier payments to employee wages. Non-operating expenses include inventory charges or the possible settlement of a lawsuit. Operating expenses include sales commission, payroll accounts, and pension contributions.
- Advertising expenses. These are expenses you use to advertise your business. They can include print fees, online media, or radio and video ads.
- Administrative expenses. These are costs you use for the business as a whole and are not usually broken down by department. They might include salaries, office supplies, rent, or travel expenses.
- Net income. Net income is the amount of money you earn after you have excluded the business expenses. You will need to subtract the total expenses from the total revenue to get this figure.
- Earnings before tax. You will need to subtract the expenses from the income you received before taxes to calculate this figure.
- Depreciation. This shows the value of certain assets you have and how they are declining as the business uses them over a time period.
Why is an Income Statement Important?
Income statements are important for all businesses regardless of their activity. Small businesses often don’t think they need one, but it’s recommended you always have income statements regardless of the size of your business. This is one of the most important financial instruments for a business and a reliable way to assess your company’s financial performance.
Having regular income statements ensures you always know the profitability of your business and can keep an eye on any changes that may appear for each reporting period. A business entity with accurate financial statements can identify unnecessary expenses and find ways to correct the financial situation before it is too late. Income statements allow for more accurate budgeting.
Types of Income Statements
Different types of income statements are used and it’s important to understand which one provides the best information about your business. If you are not sure about the best income statement format for your business, you can always ask an accounting consultant. Working with professionals in financial accounting is the most efficient way to create financial statements so that you can interpret the financial position of your business accurately.
Single Step Income Statement
A single-step income statement is the easiest to use because it only uses one calculation. Here is the basic equation of a single-step income statement:
Net income= (revenues + gains) – (expenses + losses)
These statements are common formats used by small businesses because they are easier to understand. They can also be used for any business that does not have several different lines of sales and doesn’t need separate line items.
Multiple Step Income Statement
Multiple-step income statements are used by companies that have more than one type of service, product, or location. Operating revenue and operating expenses are usually separated from the non-operating costs in order to get a clearer picture of where the money is coming and going.
Some of the calculations in multiple-step income statements include:
- Gross profit = sales – cost of goods sold
- Operating income = gross profit – operating expenses
- Net income = operating income – non-operating expenses
How to Read an Income Statement
Knowing how to read an income statement will ensure you are involved with your business deductions, have a clear idea of your sales revenue, and can assess the profitability of your business. It can also help you decide if you’re ready for investment and give you accurate insights into your business’s financial situation during a certain accounting period.
If you are using a single-step income statement, reading it will be straightforward once you understand its usage.
On a single-step statement, let’s say you have a total revenue of $40,000 and gains of $3,000 from selling an old vehicle. Your expenses are listed as $15,000 and your losses are $500 from a consumer lawsuit.
By plugging it into the formula we talked about above, you get:
Net income= (40,000 + 3,000) – (15,000 + 500) = $27,500
If you use a multi-step income statement, the process is a little more difficult, but manageable once you get used to working with it. The financial report you are analyzing should show all the costs of the goods sold which include materials, labor, and overhead. These amounts totaled together is the gross margin.
Next, you will see your operating expenses which might include selling expenses, administrative expenses, and depreciation. All of these things will total the operating income.
Other income and expenses will be shown next and show additional income and expenses like interest and extraordinary items. Lastly, you will see your net income.
Final Thoughts
An income statement is very important because you always want to know the profitability of your business. The business profitability will allow you to make important decisions and even predict your company’s future performance and future cash flows based on the patterns established by your income statement.
