There are three financial reports primarily relied upon in business accounting: the balance sheet, income statement and cash flow statement. There is also a statement of shareholder equity if applicable.
These combined financial accounting documents provide insight on the financial health of a business during the accounting period. Each document must strictly follow accounting principles for key financial ratios.
There are two income statement formats: single step or multiple step. A single-step income statement will contain less detail and is easier to produce, making it a common financial statement for smaller businesses. The multiple-step statement will offer more detail and is generally used by larger companies.
How to Use an Income Statement
Income statements are important because they offer a snapshot of business performance within a specified reporting period. Publicly traded companies are required to furnish this report to the public per U.S. Securities and Exchange Commission regulations. Investors will commonly analyze income statements for the previous five years before investing in a public company. This information can be found on the U.S. Securities and Exchange Commission EDGAR website.
Even though there is no reporting requirement, small businesses can also benefit their bottom line through financial reporting. The income statement is used to make business decisions and also to provide information to investors. It utilizes GAAP standards to track financial performance through gross margin, operating income and net income.
Key components of an income statement include sales, cost of goods sold, expenses and net income or loss. These statements are colloquially known as a profit and loss statement, or P&L. They may also be formally titled as a statement of operations or earnings statement.
What Is a Single-Step Income Statement?
A single-step income statement is a straightforward overview of expenses and revenue. The single-step statement follows the single-step format of subtracting expenses from revenue, resulting in total net income or net loss on the literal bottom line of the document.
Revenue is income before the deduction of expenses. Revenue will include sales revenue, interest revenue and other business activities that draw revenue, such as nonoperating revenue. Sales revenue comes from selling products or services, and interest income comes from investment activity.
Expenses include any cost expenditures used for business, such as selling expenses and administrative expenses, income tax and nonoperating expenses. Operating expenses are the combination of administrative and selling expenses. The cost of goods sold is the direct expense used to produce goods and services depending on the type of business; this can include labor, overhead, manufacturing costs and warehousing.
The difference between single-step vs. multi-step income statements will be the application of additional formulas resulting in additional steps.
Why Use a Multiple-Step Income Statement?
The multiple-step income statement further specifies the basic categories of an income statement into subcategories with additional formulas and associated subtotals.
Profits are broken down across the following four lines: gross profit (sometimes referred to as gross margin), operating income, pretax income and net income or net loss. These additional subcategories reflect the multi-step format.
Gross profit is the amount of net sales minus the cost of goods sold. Operating income is gross profit minus operating expenses. Net income will be operating income added to nonoperating income, according to the Corporate Finance Institute. Nonoperating income comes from sources that are not the core business.
There will often be a line for discontinued operations to separate out the profits or losses from discontinued operations. When companies merge, this particular line can be significant. In the case of stock-issuing companies, the income statement will also indicate how much income is derived from shares of stock. This will be categorized as earnings per share).
Hashaw Elkins is a financial services and tax professional, as well as a project management consultant. She has led projects across multiple industries and sectors, ranging from the Fortune Global 500 to international nongovernmental organizations. Hashaw holds an MBA in Real Estate and an MSci in Project Management. She is further certified in organizational change management, diversity management, and cross-cultural mediation.