An income statement is a vital document for any business. It’s the first thing potential investors and banks want to see before considering your funding requests. Additionally, it gives a detailed overview of your business revenue and income, allowing you to make data-driven decisions to improve your profitability.
So, getting it right is vital to building your future success. Read on as we go through what an income statement looks like and how you can prepare one for your small business.
What is an income statement?
An income statement is a financial document summarizing company income and expenses during a specific accounting period. It could be monthly, quarterly, or annually.
Also known as a profit and loss document, it’s one of three financial statements a business prepares. The other two are the balance sheet and the statement of cash flows.
Income statements record the financial activities of a business by providing a glimpse into three areas:
- Where you’re making money
- Where you’re spending money
- If the business is profitable
These are crucial figures to know. It provides a health check for your business, predicts future business trajectories, and informs decision-making by highlighting areas of concern or opportunity.
A well-prepared income statement serves to signify a financially mature company. That’s why it’s one of the first documents potential investors ask for when deciding to invest in a business.
Knowing how to create an income statement is essential to attracting investors to your small businesses and understanding where you can change your business strategies. It helps you grow, boosts ecommerce conversions, and increases your profitability.
What does an income statement look like?
An income statement reports the business revenue, expenses, and the difference between them. There are two methods of displaying this information: single-step and multi-step income statements.
Single-step statements list all the financial documents in one column, providing only the revenue and expense section without a detailed breakdown of operating costs. It makes it easier to prepare and understand, as the only calculation is the net income. It’s the total revenue minus total expenses.
However, you need more comprehensive figures and documentation to apply for small business loans or prepare documents for investors. This is where multi-step statements come in.
While single-step statements provide a simple overview, multi-step statements give a detailed breakdown of business operating and non-operating revenue and costs, such as gross profit and pretax income.
This makes it more difficult to prepare and understand, with multiple columns, sections, and calculations required. But, it outlines the financial activities in great detail, showing your business acumen and maturity to banks and potential investors.
As well as attracting interest in your small business and raising funds easier, you can identify precisely where you’re losing or making money. For example, you might move from a transcription service to a meeting transcription app to reduce costs.
Regardless of whether you’re creating a single-step or multi-step document, there are six essential components of every income statement. Let’s take a look.
1. Sales or revenue
Sales or revenue is usually the top line of an income statement and is the total amount of money earned from business products and services. It includes all sales and revenue streams during a specific reporting period. The terms sales and revenue are used interchangeably on the top line of an income report.
You can identify the profitability of your business by looking at how revenue changes between reports. Similarly, improving revenue is the fastest way to increase your profitability.
2. Cost of goods sold (COGS)
COGS is the total amount spent to design, buy, or manufacture the products, services, goods, or components sold by the business during the reporting period. It includes all labor and material costs and is always positioned directly below the revenue line.
3. Gross profit
Also known as sales profit or gross margin, this is the amount of money earned by a business before deducting operating costs. It’s determined by subtracting the COGS from revenue.
4. Operating expenses
The business operating costs is the total amount of money spent on general and administrative expenses, such as business equipment, customer service marketing, admin overheads, or business utilities.
5. Earnings before tax
This is the amount of money your business earns before deducting tax. It highlights the financial performance of your business before tax inclusion. As taxes can fluctuate, this figure gives you a good idea of your financial standing.
6. Net income or loss
An income statement is often referred to as a profit or loss document because it ultimately shows whether the company has made a profit or loss. The net income or loss is the gross profit minus the total expenses for the specified reporting period.
How to prepare an income statement
Now you know what an income statement should look like, let’s go through the steps needed to create one for your small business.
1. Pick a timeframe to report on
The first step is choosing the reporting period for your income statement. It’s a critical decision as it can influence your decision-making process and business agility.
For instance, a monthly report gives you short-term data about your financial activities, allowing you to make rapid tactical changes for your business. Similarly, a quarterly or annual report lets you identify long-term trends and implement higher-level strategies.
While publicly traded companies must prepare financial statements on a quarterly and annual basis, there’s no requirement for small businesses. Your reporting period will depend on your business goals and what you want to achieve.
However, regular reports will provide you with the necessary information to make data-driven decisions about the future of your business. This power changes for increased efficiency, productivity, and profitability.
2. Calculate total revenue
Now you know the reporting period, you can calculate the total revenue for that timeframe. This includes all the money earned from business products, services, and revenue streams, even if you haven’t received every payment. Add the total revenue as the top line in your income statement.
3. Calculate total COGS
Next, calculate the total COGS sold by your business and list them under the revenue line in your report. This includes all direct and indirect costs associated with producing and selling business products and services:
- Direct labor expenses
- Material expenses
- Distribution costs
- Manufacturing costs
- Parts or components expenses
- Any expenses involved in producing and selling products or services
Using an Electronic Data Interchange (EDI) to manage invoices and purchase orders can be helpful during this step. It prevents transactions from being lost and reduces costly human errors, ensuring your report is accurate.
4. Calculate gross profit
This is simply total revenue minus COGS and is added to the report below total COGS.
5. Calculate operating expenses
Now add up all the operating costs of your business and add them below the gross profit line.
Operating expenses are different from COGS as it’s the indirect costs associated with doing business, such as investing in conference room technologies. It doesn’t include any expenses used to produce, distribute, or sell products or services. Some examples include:
- Office furniture or supplies
- Website hosting
- Legal fees
6. Calculate income
Your total income can be referred to as Earnings Before Interest and Taxes (EBIT) and is effectively your pretax income. It’s calculated by subtracting operating expenses from gross profit and is often listed at the bottom of your income statement.
7. Calculate interest and taxes
Once you know your pretax income, you can calculate your interest and taxes. Add this figure below the pretax on your income report.
Here, taxes refers to the local, state, federal, and payroll taxes you owe for the reporting period.
Interest refers to the money your company pays on the debts or loans during the reporting period. You must know both your interest rate and the total amount of money you owe to calculate your interest charges. Like taxes, interest rates fluctuate, so make sure to use up-to-date information for your reporting period.
While this can be a tricky step, especially for small businesses that may not have the budget for an accountant, it can be done automatically through accounting software.
8. Calculate net income
Net income is added to the final line of your income statement and is the figure that shows your business performance and profitability. Calculate it by subtracting interest and taxes from your pretax income or EBIT.
If the number is negative, you’ve made a loss. But, if it’s positive, it shows the available business funds you can use to drive your business forward, such as improving remote work operating systems, adding new product lines, or creating a rainy day fund.
9. Finalize the document
Don’t forget to add key details to finalize your report. A header identifying the document as an income statement, your business details, the date created, and the reporting period are essential additions to your document.
It will allow you to better organize and review your business performance over time.
Better understand your small business
An income statement is an essential business document. It outlines your financial activities, predicts business trajectories, and lets you apply for loans to fuel business growth.
It can be a vital strategy for your PR communications plan, providing a comprehensive and accurate report to showcase your business’s success to potential investors.
Additionally, it provides you with critical information and figures to power data-driven decisions, letting you implement effective short and long-term business strategies.
Whether you’re a busy entrepreneur or the leader of a small team, learning how to create an income statement for your small business is an immensely beneficial skill that improves your financial analysis and capabilities.
Jessica Day – Senior Director, Marketing Strategy, Dialpad
Jessica Day is the Senior Director for Marketing Strategy at Dialpad, a modern business communications platform like the hosted PBX that takes every kind of conversation to the next level—turning conversations into opportunities.
Jessica is an expert in collaborating with multifunctional teams to execute and optimize marketing efforts, for both company and client campaigns. She has also written for sites such as Globalization Partners and SME news. Here is her LinkedIn.