When you apply for a small business loan, an income statement from the last three years is usually one document you need to produce. Here are the details you need to know to calculate this financial document for a lender.
What is an Income Statement?
Investopedia gives an easy-to-understand outline here:
An income statement is a financial statement that reports a company’s financial performance over a specific accounting period. Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities. It also shows the net profit or loss incurred over a specific accounting period.
Unlike the balance sheet, which covers one moment in time, the income statement provides performance information about a specific time period.
An income statement is also called a Profit and Loss Statement.
What Are Income Statements Used For?
As a small business owner, you need to know how to prepare an income statement. This important document is key to determining your company’s sales revenue and the expenses incurred to make those sales happen. These expenses are also known as the cost of goods sold (COGS), which we’ll explain more later.
With a solid sense of your gross profit and operating expenses, you can also determine your company’s pre-tax income for a period. This number can indicate how well your company is performing compared to your projections or budget needs.
Additionally, through the details of an income statement, you can determine which factors are leading to your pre-tax income exceeding or surpassing your target and reshape your budget accordingly. Beyond your company, investors, banks, and other lenders may request to see income statements to determine whether your company makes for a trustworthy borrower and establish just how much money they can lend you.
Income Statement Breakdown
- Revenue: The top line of an income statement is money coming in – sales revenue without any deduction. The bigger the number, the more expenses you can take on. A smaller number means expenses will have to be lower to stay profitable.
- Direct Costs: Direct Costs are also known as Cost of Goods Sold, or COGS. This number reflects how much it costs to make the product or provide a service. For example, a skateboard company would put down the costs of the parts and labor to assemble. Not included are items like office space costs. The number won’t be the cost of goods that are not sold, only those purchased by a consumer.
- Gross Margin: This percentage represents present of total sales revenue the company retains after incurring direct costs associated with producing goods and services sold. The higher the percentage, the more the company retains on each dollar of sales. Lenders want to know that the business can pay other costs and meet debt obligations.
- Operating Expenses: List all of your expenses as line items, excluding costs of goods sold. Include everything else your company pays for to keep up and running like rent, payroll, utilities, marketing.
- Operating Income: Earnings before interest, taxes, depreciation, and amortization. According to Investopedia, operating income is considered the most reliable number reflecting a company’s profitability.
- Interest: If you have a loan, include interest payments. Skip this line item if it doesn’t apply.
- Depreciation and Amortization: Tangible and intangible expenses associated with your assets like a car. An intangible asset might be a patent.
- Taxes: This line reflects income tax paid or that you expect to pay.
- Net Profit: Also called net income or net earnings, net profit is the true “bottom line”. A negative number indicates that you’re operating at a loss. You might have too many expenses or not enough income.
How to Prepare an Income Statement
Take the following steps to prepare an income statement:
1. Start With Your Trial Balance
The amount of money in all your accounts at the end of the period for which you’re generating financial statements is known as the trial balance. You should start by noting all your trial balances and then make calculations.
2. Add All Revenue Line Items
Add the values of all revenue line items in your trial balance. The sum that you calculate will be the revenue line item in your income statement.
3. Add All COGS Line Items
As described earlier, COGS comprises direct costs, so for this step, you’ll note the value of any direct costs during the period in question. You’ll then add all these amounts together to get your COGS line item. Place the value you determine directly below the revenue line item.
4. Calculate Your Gross Margin
With your revenue and COGS line items determined, you can calculate your gross margin. The formula is simple: Your gross margin is the difference between your revenue and your COGS. Learn more about gross margins via the SmartBiz Loans Small Business Blog: What Is a Good Profit Margin for a Small Business?
5. Calculate Your Selling, General, and Administrative Expenses
When you look at your trial balance, you should see line items for expenses beyond direct costs. These are your selling, general, and administrative expenses. Add them together, then create a new line on your income statement for this item.
6. Calculate Your Interest
If your company repays loans monthly, you’ll need to add interest expenses as a line item. Your trial balance should tell you how much interest your company has paid during the period in question.
7. Calculate Your Depreciation and Amortization
After adding your interest line item, you’ll need to add depreciation and amortization line items to reflect how your assets lose value as they age. The following Inc. article can help you with depreciation and amortization: How to Calculate Depreciation and Amortization.
8. Calculate Your Pre-Tax Income
Now that you know all your indirect expenses, you can subtract them from your gross margin to calculate your pre-tax income. You should list your pre-tax income as a line item near, but not directly at, the bottom of your income statement.
9. Calculate Your Income Tax
Often, you can determine your company’s income taxes using simple multiplication. For example, if your company is a corporation, its income tax rate is 21 percent. As such, if your pre-tax income is $100,000, then your income tax is $21,000. Record this number as a line item below your pre-tax income.
10. Calculate Your Net Income
Your net income is simple: It’s the difference between your pre-tax income and your income tax. Thus, if your pre-tax income is $100,000 and your income tax is $21,000, your net income is $79,000. Your net income should be the very bottom line item of your income statement.
11. Include a Header
Data presented with no context lacks meaning, and that’s why income statements include headers. In your header, you should indicate that your document is an income statement, include your company’s name, and state the period that the statement covers. Only after this step should you consider your income statement complete.
Income Statement Example
An income statement that follows all the above steps might look like this:
Your Business Name
Income Statement Q4 2020
Income Statement Help
Creative and proactive, business owners wear multiple hats. Sometimes finances are not in their wheelhouse. Luckily, there are plenty of resources available to help you craft an income statement for a lender. Reach out to your accountant, bookkeeper or another financial professional who can run the numbers for you. Additionally, the SBA’s Small Business Development Centers can provide assistance. Find your local center here.
If you’re seeking a small business loan, have these documents on hand.
- Personal & Business Tax Returns
- Personal Financial Statements, required from each individual owning 20% or more of the company
- Profit and Loss Statement
- Balance Sheet
An income statement doesn’t tell the whole story of your business. If you’re applying for a loan, there are other items and financial ratios considered.
Consider applying for an SBA loan, the “gold standard” in small business loans. These low- loans have low-rates, long terms and very low payments. SBA loan proceeds can be used for working capital, hiring, marketing, to pay off high interest debt, commercial real estate purchases and more
Check the status of your company before you apply with SmartBiz Advisor*, our new no-cost online educational tool.
This tool helps you learn how banks typically evaluate your business and recommends ways to increase your likelihood of approval when applying for the low-cost SBA and bank funding you deserve.
Just like a CFO in a large business, SmartBiz Advisor can educate you on how to best build your lending profile. Banks that provide SBA loans look at a number of different factors like debt coverage, debt usage and personal credit scores. SmartBiz Advisor is a free and transparent tool. Learn more about SmartBiz Advisor here.
*What you need to know: 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.