Financial statements do more than just report on a company’s finances. They can be used to help businesses make better decisions. Analyzing trends and forecasting expenses into the future help businesses know when it’s a good time to expand or buy new equipment. An income statement is a summary of a business’s revenue and expenses for a given time period.
Not only does this report show whether the business made a profit in that time, but it also summarizes the expenses related to the business, allowing management to spot trends and make key business decisions.
We’re going to look at what an income statement is, what’s included, and how to put one together. Let’s get started.
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What is an income statement?
An income statement — also called a profit and loss statement, or statement of revenue and expenses — summarizes a business’ income and expenses over a period of time. A statement is usually produced on a monthly or yearly basis.
An income statement shows the total income the company received during the period and the expenses that were incurred during that same timeframe. The bottom line on the statement is the net income or profit for the period.
The statement is part of the three main financial statements companies create, along with a balance sheet and cash flow statement. The balance sheet shows a company’s assets and liabilities, the cash flow statement shows how cash came in and was spent, and the income statement shows a company’s profits.
What an income statement includes
An income statement is created by adding up the transactions for each of the general ledger accounts below. It should summarize the activity for the time period being reported (usually a month or year).
Revenue: The recognized revenue for the sale of goods and services during the time period. It should include all revenue streams that the business is involved in. Note that for businesses using accrual accounting, revenue includes all invoices sent out during the period, and not just those that have been paid. There are also rules regarding when income can be recognized on long term contracts or projects.
Cost of goods sold (COGS): The direct costs associated with providing goods or services. This should include direct labor, materials, parts, equipment rental, and other expenses that go into producing the item or service the business sells.
Gross profit: This is calculated with a formula — total revenue for the period minus cost of goods sold.
Selling expenses: Expenses incurred for marketing, advertising, and promotion of the business. Includes all costs related to selling business goods and services.
General and administrative expenses (G&A): The indirect costs involved in running a business that are not directly related to the goods or services being sold. This includes salaries, rent, utilities, office expenses, insurance, travel, etc.
EBITDA (earnings before interest, tax, depreciation, and amortization): This is calculated with a formula — gross profit minus selling expenses minus G&A expenses.
Depreciation and amortization expenses: Expenses related to spreading out the costs of assets, like property, buildings, and equipment. These expenses are usually incurred at the direction of an accountant or CPA.
Operating income (EBIT, earnings before interest and taxes): Total income from regular business operations. Calculated with a formula: gross profit minus selling expenses, G&A expenses, depreciation, and amortization.
Interest income: Income received from investments or bank accounts. Not considered part of regular business income.
Other expenses: Miscellaneous expenses that are not part of regular business activities. This can include technology, research and development, sale of investments, etc.
Pretax income (EBT, earnings before tax): This is calculated with a formula — operating income minus interest expense.
Income taxes: Amount of taxes paid based on pretax income.
Net income: This is calculated with a formula — pretax income minus taxes paid.
Earnings per share: Used by publicly traded companies. Calculated by a formula: divide net income by the number of stock shares.
How to prepare an income statement
An income statement is prepared by adding up the transactions in each of the categories above for the period that is being reported, then doing the math for each of the subtotals. If the report is being prepared for the year to date, you can take amounts from your trial balance report to complete the income statement.
However, if the reporting period is just the current month or a quarter, you’ll need to run a report summarizing the transactions during the period or add them up by hand.
For a sample of an income statement, see this one from Granite Construction.
If you use accounting software, most programs will create an income statement for you at the touch of a button.
We’ve also provided a free template to help you create your own income statement.
Download a free template
Get an income statement template to use in Google Sheets or Excel.
Why income statements matter
Income statements are used by lenders and financing companies to assess the profitability of a business when they are requesting a loan or financing. Lenders will often look at all three financial statements to get a good feeling for where the business stands financially. They may also request income statements from past years to look for trends.
Construction companies and other companies that are required to provide bonds will need to provide an income statement to their surety. The surety uses the income statement and other financial statements to assess the financial stability of the company and determine a company’s bonding capacity.
Publicly traded companies are required to provide income statements to their stockholders and certain regulatory bodies like the SEC. Their financial statements are often posted publicly on their website.
The amount of tax a company pays is based on pretax income. Businesses produce quarterly income statements, as they are required to pay estimated taxes on the income they’ve earned.
Companies can also use their income statement to compare with other companies in a similar industry. They can gauge their standing in regards to the competition and can make changes accordingly to improve their financial position.
Income is king
Financial statements are a key reporting tool for businesses when it comes to analyzing their profitability and customer buying trends. Reviewing them on a regular basis will ensure that data is accurate, and that management always knows where the business is financially.
Income statements are particularly important because they show the total profit for the business in a time period. And everyone knows that profit is the holy grail for all businesses.