With the amount of money that regularly moves in and out of your company, you’ll need to thoroughly understand your company’s spending and earning to properly analyze its performance. This is where income statements come in. These documents break down your revenue and expenses by category for financial modeling and forecasting purposes. They’re also vital for securing additional business funding, plus you’re legally required to generate them. In this blog, learn the basics of income statements and see an example income statement so you can see this important document in action.
What is an income statement?
An income statement, also known as a profit and loss statement, is a financial document that details your company’s revenue and costs during a given accounting period. It shows your company’s net income – the difference between its net sales revenue and all other expenses – for the specified period.
Chances are that your income statement will be one of three key company financial statements you prepare. You can read the SmartBiz Loans blog’s posts on balance sheets and cash flow statements to learn all about the other two types of financial statements.
What is the purpose of an income statement?
An income statement demonstrates your company’s performance through financial figures. It details how well your divisions are bringing in revenue. In knowing this information, you can make business decisions such as product expansions or location closures to stabilize or grow your company.
Your current and potential investors and shareholders will also request to see your income statements. These entities will need a clear picture of your company’s finances to decide whether to make an initial investment, continue investing after an initial investment, or sell some or all of their shares.
Your competitors might also look at your income statement to inform their own strategies. You can do the same with your competitors’ income statements. If certain companies’ numbers suggest branching into a new service as a source for additional profit, you should consider following their lead.
Types of income statements
Your income statement can be prepared in one of two formats:
- Single-step income statement. This format only details one category each for revenue and expenses. While you might be able to work with this format since you’re innately familiar with your company’s operations, external entities such as investors won’t be able to do much with this format since it doesn’t break down expenses by category.
- Multi-step income statement. This statement format breaks down all costs by category, such as depreciation expenses, interest expenses, tax expenses, and operating expenses. As such, entities conducting a deep dive into your finances will likely find it more useful.
Figures you'll commonly see on an income statement
Among the figures you’ll commonly see on an income statement are:
- Sales revenue. This figure describes all money you earn from selling your products or services.
- Cost of goods sold (COGS). This figure entails all expenses – including but not limited to labor, materials, overhead, storage, and the wholesale price of any products resold – spent to create and sell your products and services.
- Gross profit. Gross profit is the difference between your sales revenue and your COGS. It differs from gross profit margin; another term often encountered in accounting (and one that you won’t have to factor into your income statement).
- Rent. This expense is the amount you pay to rent an office space, warehouse, or other physical space. If you rent equipment or other business items, those might fall under equipment or operating expenses instead.
- Utility. This expense entails all money you spend to keep the power on, water running, and heat and air conditioning going at your physical locations.
- Depreciation. All purchased items, including business equipment, lose value over time. The total amount of value lost during the accounting period in question is an expense that should be added to your income statement.
- Operating expenses. Operating expenses are arguably the broadest of all income statement expense categories. They include everything from payroll software to employee wages to insurance payments.
- Equipment. Any money you spend to rent, maintain, or refurbish your operating equipment falls under this expense category.
- Marketing. All money that you spend connecting your brand with potential new customers and clients goes into this category.
- Total general expenses. This category is the sum of all previous expenses. You may also see it referred to as direct expenses since all the expenses comprising this category stem from crucial business operations.
- Operating earnings. This figure is the difference between your gross profit and your total general expenses.
- Interest payments. If you’ve taken out any loans to fund your business, then you’ll have to pay interest on them. This interest is another expense you must include on your income statement.
- Total pre-tax earnings. This figure is the difference between your operating earnings and your interest expenses.
- Income tax payments. This figure is the amount your company has paid in income tax during the accounting period in question. It does not include taxes you have withheld from your employees’ paychecks – just taxes your company pays directly.
- Net income. Subtract your income tax expenses from your total pre-tax earnings to calculate this figure, which is the single most important number on your income statement. This number shows your profitability (or lack thereof) to investors, lenders, and anyone else who might want to see it.
Income statement example
To better understand how all these figures factor into your profitability, you may want to look at an example of an income statement. The below example is not based on any existing company, but the arrangement of expenses and numbers resembles what you’ll see in a real-life income statement.
Just as with this example of an income statement, all income statements show revenue before expenses. In this sample, you’ll also see interest and income tax expenses separated from other expenses. While this separation is common in income statements, you can also include these expenses alongside the others listed.
Your Business, Inc.
For Year Ending December 31, 2020
|Cost of Goods Sold (COGS)||$70,000.00|
|TOTAL GENERAL EXPENSES||$33,200.00|
|Total pre-tax earnings||$45,800.00|
|Income tax expenses||$32,000.00|
How to create your income statement
Creating your income statement may seem daunting, but it doesn’t have to be if you use the above example of an income statement as a template. With this template and thorough company bookkeeping and accounting practices, you should face few challenges creating an income statement – an important document to share with any lenders whom you approach for funding.
To discover how your business financials stack up for funding, use our easy-to-use online tool. SmartBiz Advisor™ helps you track the financial health of your business and learn how banks typically evaluate your business.* SmartBiz Advisor also suggests ways to help you improve your credit and strengthen the financial health of your business as needed. Read feedback from real SmartBiz Advisor users and sign up here.
*The information provided through SmartBiz Advisor, including the Loan Ready Score, is for educational purposes only. SmartBiz Advisor is not a financial or legal advisor as defined under federal or state law. Use of this information is not a replacement for personal, professional advice or assistance regarding your finances or credit history.