This is a guide on how to leverage your income statement and gauge the success of your company. Plus prepare a multi step income statement for expense analysis.
In this article:
- What is an income statement
- Different types of income statements
- Single step vs multi step income statement
- 3 steps to prepare a multi-step income statement
- How to read an income statement
What Is An Income Statement?
An income statement is like a business report card. It tells a company the revenue gained and the expenses incurred in a month, quarter, or year. This financial statement draws a straight line to the viability of a company’s operations by presenting an organized view of earnings.
Income Statement AKA
- Profit & Loss Statement (P&L)
- Profit & Loss Report
- Statement of Profit
- Statement of Operations
- Statement of Comprehensive Income
Income Statement vs P&L Statement
There is no difference between an income statement and a Profit & Loss statement—they are the same. An income statement is often referred to as a P&L statement because it is short for the profit and loss of a company.
Income Statement vs Cash Flow Statement
It is easy to confuse the income statement with the cash flow statement. Since it is strikingly similar to the “cash from operations” section on the cash flow statement. However, a cash flow statement only shows the company’s cash position, not profitability.
A cash flow statement is concerned with the literal cash inflows and outflows of a business. It shows how much money is circulating to keep the doors open. A cash flow statement will include payouts like loan premiums, credit card bills, and owner’s draw. Whereas your P&L only shows the revenue streams and expenses that directly affected your profit.
Difference Between An Income Statement vs Balance Sheet
The critical difference between an income statement vs a balance sheet is revenue recognition. What is revenue recognition? When all business actions are verified, revenue becomes income, and it is reported on the income statement.
For revenue to be recognized, a business needs to fulfill the obligations of a sale. Revenue is considered income when there has been an exchange of goods or services for money. In layman’s terms, you earned a sale, the customer received something of value, and there is a receipt to prove that it was done correctly.
A balance sheet tracks money changes in your entire chart of accounts. It channels the effects of daily business activity into asset accounts (what a business owns), liability accounts (what a business owes), and owner’s equity accounts. Including items where revenue has not been recognized yet. For example: the unearned revenue account records money that has been received for goods or services coming at a later date.
The income statement looks at the past. It answers how income was earned and “the damage” it cost you to earn it. The balance sheet shows your present stance at the date of the report, across all accounts.
What Are Income Statement Accounts
Income statement accounts are set apart from other balance sheet accounts because they are nominal or temporary accounts. Balance sheet accounts are permanent because they are continuously being updated from year to year, like a running till.
Income statement accounts, on the other hand, are only measured yearly. For a clear evaluation of profit, they are closed at the end of the calendar year, and balances are zeroed out for the new year. The summary of closed revenue and expense accounts are added into the equity section of a balance sheet, as the owner’s capital or retained earnings.
Here are examples of income statement accounts:
Different Types Of Income Statements
Here is a list of income statements to tap into when you want to harness your business vision. Most small businesses won’t be concerned with these formats, still, it is good to know what your financial reporting options are:
- Partial Income Statement: specifically for companies who’ve been open less than a month, but still need to tally net income for a monthly closeout.
- Single Step Income Statement: it groups revenue and expenses into a list with net income totaled at the bottom.
- Multi Step Income Statement aka Classified Income Statement: breaks apart revenue and expense groupings from the single-step income statement into 3 separate sections—gross profit, operating expenses, and non-operating items with net income at the bottom.
- Comparative Income Statement: presents multiple income reporting periods side-by-side to view performance and build financial forecasts.
- Condensed Income Statement: this is the post-it note of income statements, financials are quick summarized lines like total revenue, total COGS, total operating expenses.
- Contribution Margin Income Statement: re-organizes COGS in the multi-step income statement so only variable expenses are included in the upper revenue portion, and fixed COGS are pushed to the bottom of the statement to emphasize gross profit per product.
Note: Just because you use a different format, doesn’t mean you get different numbers! Each type of income statement you use in the same period should always arrive at the same net income.
Single Step vs Multi Step Income Statement
The two most popular types of income statements are single step and multi step. Both report revenue and expenses and both will result in the same net income. See how they differ below:
What Is A Single Step Income Statement?
The single-step income statement is the most recognizable format. It has 2 sections listing all items of revenue and all expenses. Many operating expenses will be grouped into one line to simplify calculations.
A single-step income statement follows this formula to find net income:
(Total Revenue + Total Gains) – (Total Expenses + Total Loss) = Net Income
The format of the income statement orients revenue, expenses, and net income exactly like the formula. See the single step income statement example below:
What Is A Multi-Step Income Statement?
A multi-step income statement breaks down expenses further than a single step by 3 formula steps. Instead of listing and grouping certain items, you see revenue less the largest expenses, helping you arrive at gross profit. Additionally, a multi-step income statement divides operating revenue and expenses from non-operating to pinpoint net profit.
Here is the net income formula for a multi step income statement:
Gross Profit – Operating Expenses + Non-Operating Expenses = Net Income
The formula can also be viewed like this:
(Total Revenue – COGS) – Operating Expenses + Non Operating Expenses = Net Income
Generally, there are 4 sections to a multi-step income statement. However, companies will format their headers and sub-headers differently. The main objective is to show COGS, Gross Profit, Operating Expenses, and Non-operating expenses to find net income. See the example below:
When To Prepare Single Step vs Multi Step Income Statement
Both a single step and multi step income statement have advantages for reporting. Single-step income statements are simple to prepare and display net income as the focus metric. It is a way to show investors and management outside of the financial field, a snapshot of profit and loss.
The multi-step income statement is preferred because it provides more granular financial data. Categorizing revenue and expenses in this format shows the complete company picture. In a funding application, you want to give your creditors and investors proof you are the pudding.
Multi-step income statements also aid income projection models. When forecasting income, it is important to have detailed historical data for accurate predictions of business.
What Types Of Businesses Prepare Single Step vs Multi-step Income Statement
Small businesses and companies in the service industry prefer the single-step income statement. Complicating procedures with just a few revenue streams isn’t conducive in accounting. Generally, eCommerce and large mid-level companies prefer the multi-step income statement because it translates the complexity of their high sales volume into a readable P&L.
Companies that are publicly traded, in compliance with GAAP, have strict reporting rules for income statements. They are required to have multi-step income statements for each period, to show whether expenses are ordinary and necessary to the business. This is so governing agencies can have a clear window into what they are doing financially, in the name of public trust.
3 Steps To Prepare Multi Step Income Statement
Creating a multi-step income statement compiles 3 accounting formulas to find net income.
Follow along with our quick guide to build your own multi step income statement. Start with your gross sales revenue, then move through each section reporting accounts on the left and totals on the right.
1. Gross Profit Section
Gross profit is found in the top part of the multi-step income statement. First, you need to calculate net sales (the sum of a company’s sales minus returns, discounts, and allowances). Then subtract the COGS from net sales to find gross profit.
See the gross profit formula in action in the example below:
Gross Profit = Net Sales – Cost of Goods Sold
|Gross Sales Revenue||$10,000|
|Gross Sales Revenue - Returns, Discounts, Allowances = Net Sales||$10,000 - ($1,000) = $9000|
|Net Sales - COGS = Gross Profit||$9,000 - $3,500|
Note: Gross profit is central to the multi-step income statement. This number is a good indicator of whether a company is profitable or not. A single step does not show gross profit, and therefore provides a mere glimpse at how a company earned income.
2. Operating Expenses Section
In this section, you are finding your operating income after essential expenses. This gives you how much operating income your business can generate while managing fixed operating costs. Your total operating expenses are subtracted from gross profit, from the previous section, to show operating income.
Operating Income = Gross Profit – Operating Expenses
|Contracts, Wages, Salary, and Benefits||($700)|
|Web Hosting & Domain||($100)|
|= Total Operating Expenses||($1450)|
|Gross Profit - Operating Expenses = Operating Income||$5500 - $1450|
Note: It is a personal preference to group expenses under subheadings like “selling expenses,” “office expenses,” etc. Whatever you see fit, but you still need to lay out each operating cost on its own line.
3. Non-Operating Expenses Section
The non-operating expenses section tallies accounts that are not related to day-to-day business. Operating income from the previous section is then added to non-operating items. The final figure shows the net income (or net loss) of the business for the reporting period.
Net Income = Operating Income + Non-operating Items
|Gain/loss on sale of assets||$450|
|Interest income or expense||($50)|
|= Total Non-Operating Items||$200|
|Operating Income + Non Operating Items = Net Income||$4050 - $200|
How To Read A Multi Step Income Statement
Going from top to bottom here is how to read your multi step income statement. Each metric will help you make more informed decisions and drive action in your company.
- Gross Revenue is at the top. Although it gets chopped up down the page, it gives you a point of reference for how much you are taking in compared to how much is being spent.
- COGS is going to be the largest expense for most businesses. This figure accounts for the total costs to produce your product. Do you see areas that need improvement?
- Gross Profit is a measurement of your highest profit potential and can only be altered by cutting COGS or increasing sales.
- Operating Expenses are the next area to refine when you are trying to cut costs. You’ll need to isolate which expenses are workable or negotiable.
- Operating Income is the first area investors and creditors will look at to measure profitability. They want to see that management is taking care of operational expenses with ease.
- Non-Operating Items tend to take the backseat when it comes to increasing net income. However, optimizing these lines can be just the right step toward increasing income. Perhaps you can encourage more public interest in investment, cut your tax expenses or make a plan to pay back your loan?
- Net Income is the bottom line. If you are reporting a loss, that is not necessarily bad. It could mean that you are spending time, effort, and resources on research and development. But, there should be enough funds swirling around to cover operating expenses and remain solvent. This metric also indicates to management how much is available for retained earnings, or the owner’s profit.
P&L: The Gateway To Better Business
Revenue – Expenses = Net Income that is the income statement. No matter the format, whether you use the laundry list of revenue and expenses like the single step, or you break down your profit and loss statement using multiple steps; you will always circle back to the same net income. Successful business owners leverage this statement as a cheat sheet for operational moves. It is how to see exactly why you are turning a profit and how to punch the needle in your industry.