An updated income statement helps owners understand and analyze the business’s profits and losses. The statement is a living document that shows whether a company is successful, and how to prepare an income statement can be simple once you know the essentials.
What Is an Income Statement?
An income statement is a document showcasing and analyzing the profits and losses of your business. Also known as a “profit and loss statement” or “statement of earnings,” it includes items such as:
RevenueCost of goods soldExpenses Taxes
Many small businesses may choose not to create an income statement because they think their profits or costs are too small to analyze. However, scaling operations becomes extremely difficult if you don’t have historical information on your earnings, losses, and trends. An income statement answers a key question for businesses big and small: Is the business operating in the black (positive earnings) or red (negative earnings)? An income statement that shows healthy profits marks the company ready for growth; a statement showing extensive loss signals that operating costs must decrease or sale prices must increase.
How To Prepare an Income Statement
Income statements present a summary of all profits and losses incurred by a business in a selected timeframe. Preparing the document takes a lot of financial data to arrive at this holistic overview, including operating costs, net income, cost of goods sold, and more.
Sales
The first line of an income statement acts as the first step in your income statement. Sales, also called “operating income,” is the total amount of money brought in from goods and services you sold. You may combine sales in one line or separate based on product line or other revenue-generating categories. Sales may be shown as gross revenue or gross sales, though each represents the same information: how much you brought in from selling your product.
Calculate Cost of Goods Sold
Also referred to as “COGS,” the cost of goods sold is the money spent to produce the product or service for sale. A common example is the cost of materials to make a product. Add up the various costs directly related to production. COGS appear right underneath the sales section of the income statement.
Profit
Profit is total revenue minus COGS. COGS is subtracted from total sales to arrive at gross profit, appearing at the top of the income statement under the first two lines. The money is “gross” as expenses have yet to come from it.
Operating Costs
Operating costs or “operating expenses” is money spent not linked to your product or service. Costs in this section usually include office rent, payroll expenses, supplies, and utilities. Other operating costs that can show up on an income statement include marketing expenses and miscellaneous expenses.
Operating Income Before Taxes
At this point, your total expenses are subtracted from gross profit to create the operating income before taxes. Your pretax operating income is important for equity analysis processes as outlined by the CFA Institute, as equity markets give valuations based on high or low-earning companies at this phase of the income statement.
Taxes
The amount of taxes paid or expected to pay is subtracted from the operating income. It is necessary to take out taxes to arrive at the bottom line and demonstrate how much money the company lost or gained during the period.
Net Income
Net income is the final line item on your income statement, as it shows whether you’re operating in the black or red. Your net income is the income left after subtracting all expenses from your gross profit.
Income Statement Example
title: “How To Prepare An Income Statement” ShowToc: true date: “2022-12-27” author: “Karen Josey”
The income statement shows the profitability of the firm over a period of time. Set your income statement up by first choosing a time frame, such as the current month, quarter or full year’s worth of accumulated financial results. The income statement table below is presented with a line-by-line explanation so you can look at the profit or loss after deducting each expense. Line 1 shows the gross revenue or sales figure. It equates to the total amount of sales in dollars that the firm has made for the given income statement period. If your firm sold 40,000 widgets at $25 each, you would show $1,000,000 on the sales line. You would show the amount sold, even if you’ve billed your customers but haven’t yet collected the money. Line 2 has a $500,000 entry for cost of goods sold. This cost covers the purchase of units of your product for sale. Cost of goods sold is often a firm’s largest expense. Cost of goods sold contains all costs directly related to producing your product, such as direct labor, and purchases of raw materials. If you buy goods wholesale and then resell them, you would also reflect that on this line. For example, 40,000 widgets purchased at a wholesale cost of $12.50 each equals $500,000 cost of goods sold during the period reflected on this income statement. Line 3: Subtract the cost of goods sold from gross sales to get gross profit (Line 3). Line 4: From the $500,000 gross profit, subtract selling and administration (S,G&A) expenses. This $250,000 item represents your office expenses, such as costs not directly related to producing goods for sale. If you have several related expenses, such as telephone, electric and water bills, you can group them into one line called “utilities.” S,G&A expenses also include costs like wages, sales commissions, office rent, and legal and accounting fees. Line 5 shows the company’s depreciation expense. When you buy a building or equipment for your business, you depreciate it over a period of time. Depreciation is a non-cash expense and serves as a tax shelter, so it is shown on the income statement. Line 6: After subtracting selling and administrative expenses and depreciation, you arrive at the operating profit. Operating profit is also called earnings before interest and taxes (EBIT), which in this case totals $170,000. Line 7: After you calculate EBIT, add your company’s interest expense. Interest is what you pay on any debt your company owes. To calculate the interest on the debt, you have to know the interest rate you are paying and multiply it by the principal amount of your debt. For this example, the interest amount is assumed at $30,000 and goes on Line 7. Line 8: After subtracting your interest expense from EBIT, you arrive at earnings before taxes on Line 8. Line 9: Fill in the amount you pay in federal, state, local, and payroll taxes on Line 9. The tax rate, in this example, is 21 percent. Line 10: After you subtract the tax expense, you’ll arrive at the earnings available to your common shareholders, which is stated on Line 10. Line 11: If you have investors in your firm or if you take a salary from your firm, Line 11 is where you record the draw or the dividends. Line 12 Subtract all of the expenses above from line 3, gross profit, to calculate your company’s net income (profit). This represents the money you have left to put back, or reinvest, into the firm in the form of retained earnings. Transfer this net income amount to your balance sheet at the end of your accounting period, to the retained earnings account. Aside from being reinvested in the company, this amount might also be used to pay future dividends. The table below shows an example of a very simplified income statement. The income statement of your company may be a little more complex and contain more line items. This statement should serve to give you the basic layout and an idea of how a profit/loss statement, or income statement, works. XYZ Company Income Statement For the Year Ending Dec. 31, 2018
