There are three major financial documents that you should prepare every period for your business and the income statement is one of them. It is important to understand how to read and use your financial statements properly for them to be of any use. After going through this article, you will have a better understanding of your income statement so you can use it to make the best decisions for your business.
Your Income Statement – What is it?
The income statement is a report that summarizes the revenues and expenses your company saw for a given period and provides the resulting profit or loss. This statement is also known as the “Profit and Loss Statement” (P&L).
The income statement will list your business’s revenues from all sales and services and all the expenses, such as rent, supplies, utilities, and taxes. When you subtract the expenses from the revenue, you are left with the net income, also known as the bottom line (since it is the last line on the income statement).
What does an income statement look like?
Before we dive into the specifics, let’s look at an example of an income statement. This is an income statement for a fictional business that does landscaping, Joe’s Lawns.
For year ended December 31, 2021
|Lawn Service Income||138,450|
|Sales (wood chips/mulch)||53,400|
|Cost of Goods Sold||(47,550)|
|Total Operating Expenses||(112,450)|
|Earnings Before Income Tax||27,350|
|Income Tax Expense||(7,000)|
Let’s dive in deeper and look at each part of the income statement so we get a better understanding of each part.
For Year Ended
You may have noticed under the business name the words “For Year Ended”. This just tells the period for which the income statement covers. The very first step in putting together an income statement is knowing the period which you are going to look at.
In this example, we are looking at a yearly income statement covering all of 2021.
The first thing listed on every income statement is the revenues. In our example above, Joe’s Lawns has money coming in from lawn services (such as mowing and trimming), but he also sells mulch and wood chips, so he gets revenue from those sales as well.
Since Joe’s Lawns has two sources of income (services and sales) we also included a total revenue line.
Cost of Goods Sold
As you probably know, Cost of Goods Sold, commonly known as COGS, is the cost to produce the goods and services your company provides. For service companies, it can also be called Cost of Sales.
The items included in your COGS are the direct expenses associated with your products or services. This can include raw materials, labor, packaging, and shipping costs.
Gross profit is your revenue minus your COGS. This number shows you exactly how proficient your business is by only accounting for how much it costs to make the product (COGS) and how much you are earning from the product (revenue). If you notice that your costs to make the products are almost matching how much you get from selling those products, you know you need to adjust by lowering your COGS or raising your revenue.
In the expenses section of the income statement, it will list all indirect expenses such as Rent and Advertising. On Joe’s Lawns’ income statement, we listed out the expenses separately, to get a full picture of where money is going. However, it is not uncommon for a business to lump all the expenses together under one line on the income statement.
Operating income is the amount left after subtracting the operating expenses from the gross profit. This number illustrates the profitability of your business.
If you owe any creditors, you most likely are paying interest on your loans. Any interest you pay over the period is recorded in the Interest Expense line.
Earnings Before Income Tax
This is exactly what it sounds like, it is your business’s earnings before you pay your income taxes.
Income Tax Expense
This is the amount of income taxes your business paid.
The net income, the last (or bottom) line on the income statement, can be positive or negative. If it is positive, you had profits for that period. If it is negative, it is called Net Loss, which means you lost money during that period.
How do you prepare an Income Statement?
Now that we have gone over what an income statement looks like and what each category on it is, how do you prepare the actual document? While you don’t need any accounting software to prepare an income statement, it does make it a little easier.
Here are the steps to creating an income statement:
- Decide the period you want to create the statement for (A specific year, month, quarter?).
- Gather your books! Transfer your revenue and expenses listed in your books to the income statement.
- Enter any other gains or losses your business may have.
- Calculate! Add the revenue and gains figures and subtract out the expenses and losses to determine your net profit/loss.
The key to creating any of the financial reports your company needs is good bookkeeping. If your books are not up-to-date and accurate, these statements will not provide reliable information. Remote Books Online can make sure your books are in order and produce the income statement on your behalf.
Single-Step Income Statements
Our example above with Joe’s Lawns is considered a multi-step income statement. A single-step income statement is similar but involves fewer calculations. The Gross Profit, Operating Income, and Earning before Income Tax are not listed or calculated on the single-step income statement. A single-step income statement illustrates the net income equation much more clearly.
|Net Income = (Total Revenues) – (Total Expenses)|
Let’s look at a single-step income statement.
Imagine another fictional business, this time the income statement will be for a food truck owner. The business is named Harry’s Hots, it is a food truck that sells all kinds of hot dogs.
Here is Harry’s Hots’ single-step income statement:
For year ended December 31, 2021
|Cost of Goods Sold||(17,000)|
|Income Tax Expense||(3,000)|
Harry’s Hots has fewer expenses than Joe’s Lawns, but the single-entry income statement can be used for either business. It has less information, but it can be helpful still as it is a simpler statement.
What is a common size income statement?
Yes, there is another type of income statement that you should know about. The common size income statement is just a regular income statement with an extra column. In that extra column, each line is calculated as a percentage of the revenue.
This extra column is useful as it can easily show you any changes in the amounts over multiple income statements.
Let’s add that extra column to Harry’s Hots’ income statement.
For year ended December 31, 2021
|Cost of Goods Sold||(17,000)||35%|
|Income Tax Expense||(3,000)||6%|
With the percentages included, we can easily see that 70% of Harry’s Hots’ revenue went to expenses and the other 30% was profits.
Where is depreciation included on the income statement?
Depreciation is when you spread out the total cost of an item purchased over a given time frame. For example, if Joe’s Lawns bought a brand-new mower, they most likely do not want to enter that entire amount in one period. Imagine the income statement for that quarter for Joe’s Lawns if they did, it would probably look like a giant net loss!
To avoid a big purchase from skewing your records, you spread it out over a certain period, this is called depreciation.
So where does it show up on the income statement? It depends.
If the item you are accounting depreciation for is used in the direct process of creating your product such as a fryer for Harry’s Hots or a mower for Joe’s Lawns, it will be included in the COGS amount. If the item is an indirect expense, such as a new desk and chair for the office, it will be listed under the expenses section on the income statement.
How is an income statement different from a balance sheet?
The balance sheet is another one of the three major financial documents that must be prepared regularly for your business. The balance sheet is different from the income statement. As we already went over, the income statement displays revenue and expenses and the resulting net profit or loss. A balance sheet, on the other hand, displays your business’s assets, liabilities, and equity.
An income statement illustrates your profitability, while a balance sheet illustrates your liquidity. Both things are important to know and look at regularly, but they provide you with different information.
What’s Remote Books Online?
Remote Books Online is an online bookkeeping service that aims to meet all of your bookkeeping needs on a timely basis. Once you sign up for Remote Books Online’s services, you will be assigned a dedicated bookkeeper and lead accountant. There is no contract, and your first month of bookkeeping is on us! We would love the opportunity to show you how we can take the stress out of the bookkeeping process and provide you with accurate and up-to-date financial statements every month.