What Is an Income Statement?
An income statement, otherwise known as a profit and loss statement, is a summary of a company’s profit or loss during any one given period of time (such as a month, three months, or one year).
The income statement records all revenues for a business during this given period, as well as the operating expenses for the business.
Related: The 300 Best Small Business Ideas
What Are Income Statements Used for?
An income statement is one of the most important business financial statements. You use an income statement to track revenues and expenses so that you can determine the operating performance of your business over a period of time. Small business owners use these statements to find out which areas of their business are over or under budget.
These statements allow you to pinpoint specific items that are causing unexpected expenditures, such as cell phone use, advertising, or supply expenses. Income statements can also track dramatic increases in product returns or cost of goods sold as a percentage of sales, and can be used to determine income tax liability.
Income statements, along with balance sheets, are the most basic elements required by potential lenders, such as banks, investors, and vendors. They will use the financial reporting contained therein to determine credit limits. Your income statement could decide if you get a loan or not.
Related: How to Start a Business in 5 Steps
How to Prepare an Income Statement?
To prepare an income statement, you need to understand each individual component.
The sales figure represents the amount of revenue generated by the business. The amount recorded here is the total sales, minus any product returns or sales discounts.
Cost of Goods Sold
This number represents the costs directly associated with making or acquiring your products. Costs include materials purchased from outside suppliers used in the manufacture of your product, as well as any internal expenses directly expended in the manufacturing process.
In a service business where you, as the owner, are the only expense in supplying the service, and you do not pay yourself a salary beyond the company profits, your service expense may be zero. However, in a service business where you pay yourself a salary or have employees, the cost of their labor, including benefits, would be part of your cost of goods sold.
Gross profit is calculated by subtracting the cost of goods sold from net sales. It does not include any operating expenses or income taxes.
These are the daily expenses incurred in the operation of your business. In this sample, they are divided into two categories: selling and marketing and general/administrative expenses.
- Sales salaries: These are the salaries plus bonuses and commissions paid to your sales staff.
- Collateral and promotions: Collateral fees are expenses incurred in the creation or purchase of printed sales materials used by your sales staff in marketing and selling your product. Promotion fees include any product samples and giveaways used to promote or sell your product.
- Advertising: These represent all costs involved in creating and placing print or multimedia advertising.
- Other sales costs: These include any other costs associated with selling your product. They may include travel, client meals, sales meetings, equipment rental for presentations, copying, or miscellaneous printing costs.
- Office salaries: These are the salaries of full- and part-time office personnel.
- Rent: This is the fee incurred to rent or lease office or industrial space.
- Utilities: These include costs for heating, air conditioning, electricity, Internet, and phone usage incurred in connection with your business.
- Depreciation: Depreciation is an annual expense that takes into account the loss in value of equipment used in your business. Some examples of equipment that may be subject to depreciation include computers, office furniture, automobiles, and buildings that you own. If you don’t understand depreciation, don’t worry; I will explain it more carefully in a separate section.
- Other overhead costs: Expense items that do not fall into any of the above categories or cannot be clearly associated with a particular product or function are considered to be other overhead costs. These types of expenses may include insurance, office supplies, or cleaning services.
More financial statements samples for your business: Sample Business Plan financials
This is a tabulation of all expenses incurred in running your business, exclusive of taxes or interest expense on interest income, if any.
Net Income Before Taxes
This number represents the amount of income earned by a business prior to paying income taxes. This figure is arrived at by subtracting total operating expenses from gross profit.
This is the amount of income taxes that you owe to the federal government and, if applicable, state and local government.
This is the amount of money the business has earned after paying income taxes.
Income Statement Example
Before creating your own, take a look at our sample income statement: