Every business maintains three types of Financial Reports or statements that summarize the performance of the company. The income statement is one of the three critical financial reports of a business. The other two being the balance sheet and cash flow statement.
This article will detail out everything you need to know about an Income statement, which is also referred to as the profit and loss statement
- What is an Income Statement
- Uses of an Income Statement
- Understanding the Income Statement
- Types of an Income Statement
- How to make an income statement
- The bottom line
What is an Income Statement?
The first thing you need to know about an Income statement is that it is a storyboard of a company's finances. If you want to see a company's profit and loss, an income statement is the easiest way to do it. In absolutely simple terms, it is the total revenue and expense of a business for a specific period. Additionally, an income statement provides valuable insights on how efficiently a company is operating.
The income statement answers the most pertinent question for your business, "How well is the company performing?" Or colloquially, "Is it making money?"
Investors, accountants, and business owners regularly review an income statement to see if they are on track for its expected target. An income statement is examined to identify a specific strategy's shortcomings and nudge it in the right direction.
Uses of an Income Statement
There are several uses of an income statement though the primary purpose is to convey a business's profitability and activities. It provides micro insights if created for departments within a company.
Based on the income statement, management and investors can decide on the strategy of a particular product or department or the entire company. While a yearly income statement gives an idea of the annual plan to be placed for the next year, monthly and quarterly reports can make it easier for a short term change in strategy.
Based on an income statement, key decisions such as increasing production capacity, pushing sales, targeting a new audience, or shutting down and opening a new department can be taken.
Research analysts use an income statement to compare the quarter-on-quarter and year-on-year performance of a company. Investors can also know if the management has been able to keep a tab on overhead operating expenses without compromising productivity.
Understanding the Income Statement
When it comes to a company's financial health, an income statement is one of the most important documents. The three main components of an income statement are-
There are two ways in which businesses can prepare their income statements
Single-step income statement
It is a basic report of a company's profit prepared using a single equation to calculate net income.
Net Income = (Revenues + Gains) – (Expenses + Losses)
Multi-step income statement
It calculates the net income using a three-step process.It separates operational revenues and expenses from non-operational ones
Gross Profit= Net Sales - Cost of Goods Sold
Operating income = Gross Profit - Operating Expense
Net Income = Operating Income + Non Operating Items
Here is a real example of Amazon’s income statement, for the years ended December 31, 2015 – 2017.
Any income statement template will consist of the below items:
Revenue:An organization's income or the money that your business brought in within a specific period of time
Expenses: An organization's outflow of cash. Expenes are broadly divided into two parts cost of sales/ COGS and SG&A
- Costs of Goods Sold (COGS): The direct costs of producing goods that the company sells
- SG&A- The selling, general, and administrative expenses that your business incurs
Gross profit: The profit a company makes after deducting the COGS with the revenue
Operating income: The income of the company after subtracting gross profit from operating expenses (including COGS, wages, and depreciation).
Income before taxes: Income before taxes are calculated
Net income: Income left after deducting all costs, expenses, and taxes
Earnings Per Share (EPS): Division of net income by the number of outstanding share
Depreciation: The decreased value of an asset within a defined period
EBITDA: Earnings before interest, depreciation, taxes, and amortization
The above items can further be divided into different categories. For example, expenses can be broken down to wages, interest paid on debt, procurements costs, and wages. The chart below shows a detailed breakdown of Income statement.
You can download free Income statement templates of businesses like manufacturing, merchandising etc from the Deskera page.
How to make an Income Statement
Let's take a look at how to create an income statement.
Follow the steps given below and add them to a sheet to create a basic template.
1. Reporting period
To prepare an income statement, we begin by determining a specific period for the income statement. The period can be in the form of a monthly, quarterly, or annual basis. Public traded companies usually have a yearly income statement, while smaller ones tend to create a monthly or quarterly report.
Once you identify the reporting period for your income statement, you will need a trial balance report. That report will give you the end balance of each account and the figures required to prepare an income statement.
After you have the balance report, you will now need to calculate your total sales revenue. The total revenue will include all of your business's income, even the payments which haven't been received yet. Add everything, and you will get your revenue.
The Cost of Goods Sold is determined by adding up direct labor, overhead expenses, and materials. Add the total cost of goods sold to your sheet
Subtract the COGS from your revenue, and you will have a gross profit figure.
6. Operating expense
Add up all your operating expense costs mentioned in the balance report and enter it in your sheet.
7.Income before taxes
Subtract your selling and administrative expenses from gross profit to determine your income before taxes.
8. Net income
Subtract your gross profit with all expenses, including wages, taxes, and COGS. Net income is obtained after that.
The Bottom Line
A balance sheet, cash flow statement, and annual report with income statements help an individual determine the future financial trajectory of a business and its value and efficiency.
Analysis of an income statement can reveal if the sales are improving, the cost of goods sold is falling or if the return on equity is rising. If you are planning to invest in a company, an income statement will be one of the most critical documents you need to evaluate.
Learning to read, understand, and knowing how to create an income statement enables you to make informed decisions about a company or business. To make things easier, it is good to invest in cloud accounting software like Deskera to automate your business processes. With a solution like Deskera, all the income statement accounts will be auto-populated based on the system's business activities, making the process error-free and more uncomplicated.
Visit Deskera's website today to find out more about Deskera's accounting products. You can even sign-up for a 30-day free trial.