An income statement, also known as a profit and loss statement or P&L statement, is an important financial statement. It contains information that’s key to managing and leading a company and to its investors as well. It itemizes a company’s expenses and income over a determined period of time, often one year. It’s a measure of a company’s financial health, and answers the question: has the business experienced a loss, or has it earned money?
What’s the Purpose of an Income Statement?
An income statement sets forth all of a business’s income and expenses. It measures the overall effect of transactions over the course of the determined time period. This includes expenses and losses as well as gains and revenue, according to Harvard Business School. The statement shows the company’s performance over time.
It can be used to pinpoint periods of time when costs and expenses increase, what it’s costing the company to achieve its purpose (such as to manufacture and sell a product) and whether it has ample revenue to invest back into the business.
What Are the Parts of an Income Statement?
Income statements show many key business components such as:
- Selling expenses
- General and administrative expenses
- Cost of goods sold (COGS)
- Gross profit
- Operating income (Gross profit minus operating expenses)
- Income before taxes
- Earnings per share (EPS) (for publicly traded companies)
- Earnings before interest, taxes, depreciation and amortization (EBITDA)
- Net income
These areas can be further broken down. Expenses might be divided up into different categories and line items.
Net profit or net income isn’t the same as gross profit or income. Net profit is representative of profit after deducting all taxes and expenses.
How to Prepare an Income Statement
Harvard Business School also sets out chronological steps to preparing an income statement.
- Decide on the reporting period. You’ll first want to decide on the time period you want the statement to cover. This is referred to as the “reporting period.” It might be a month, a quarter or a year. Now identify the company’s total revenue during this time.
- Move on to costs and expenses. Cite the cost of goods sold: the expense of producing or creating whatever it is that your business is selling. This can include labor, materials and distribution costs. Subtract the cost of goods sold and the cost of sales from revenue to arrive at your gross profit.
- Calculate your operating expenses, those that are directly related to your ongoing business activities. Think items like rent or mortgage, payroll and supplies. You can arrive at your business’s total income by subtracting the total of these expenses from your gross profit. This is your pretax income and it doesn’t include interest expenses.
- Calculate “EBIT” or earnings before interest and taxes. This gauges the impact of that interest and those income taxes. You might need an accountant’s help to pin down your interest expenses because rates will vary across loans. When determining income taxes, be sure to include federal and state taxes and local taxes, if any.
- Subtract interest and taxes. You’re almost done. The last step is to subtract interest and taxes from the total income you calculated without factoring in interest and taxes. This tells you the bottom line: the total amount of money available to your business during that period of time.
Income Statement vs. Balance Sheet
Income statements and balance sheets serve two different purposes. Your income statement is a detailed snapshot of expenses and income, whereas a balance sheet details liabilities and assets, including equity. You’ll need two balance sheets for your chosen reporting period, according to the Oklahoma State University Extension: one for the beginning of the period and one for the end.
Frequently Asked Questions
What Are Cash Flow Statements?
The focus of a cash flow statement is on the actual cash that flowed in and out of the business over a cited time period. The University of Nebraska, Omaha points out that a company may appear profitable on its income statement, but still not have sufficient cash on hand to meet expenses, such as payroll, purchasing inventory or paying the rent.
What Is the Difference Between Revenue and Profit?
Profit is the income that’s available to your business after allowing for debts, expenses and costs, and adding in all available income streams. It includes “noncash” items like depreciation. Revenue is the total money that comes into your business from operations.
What’s the Difference Between Gross Margin and Operating Margin?
Both operating and gross margins gauge a company’s financial performance and can indicate whether it’s likely to make money or lose money moving forward. Gross margin reflects how much revenue it has available after direct costs for production have been accounted for. Operating margin subtracts all expenses with the exception of taxes and interest. You’re effectively subtracting additional costs and expenses from your gross margin to arrive at operating margin.
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.