The Income Statement which is often referred to as a Profit and Loss Statement or P&L Statement, is probably the most commonly used financial statement and is also one of the easiest of the three primary financial statements (Income Statement, Cash Flow Statement and Balance Sheet) to read and fill out. It is also the first one you need to build because the rest of the basic financial statements are partially built off of it.
When running a business, it’s important to evaluate the profitability of your business. Even if you aren’t a numbers person by ignoring this statement you don’t have the data on whether the business is profitable or not and are potentially overlooking opportunities to make more money.
This statement summarizes the historical financial results of a business’s revenues and expenses over a selected period of time.
The income statement equation shows the profits that were obtained through revenue and expenses. At its most simple, the calculation for an income statement is: Income = Revenue – Expenses
Unlike the balance sheet that looks at a particular time period, the purpose of an income statement is to see how much a business earned and spent in a specific accounting period. The statement is often used at the end of a business period (monthly, quarterly or annually). After a business has been operating over several years, this statement can be used to evaluate financial performance over previous years to provide data and evaluate the year over year performance.
This financial statement can also be used to track revenue and expenses to plan annual budgets and sales projections along with determining what areas of the business are over budget or under budget.
Businesses selling physical goods can use the income statement to track changes in returns, cost of goods or operating expenses as a percentage of sales to quickly fix issues in the business.
Last, the income statement can be used to estimate income tax liability as it includes depreciation, which is used as a business write-off.
Preparing an income statement isn’t super difficult to do but can be easily done by an accountant or with accounting software. The actual format of the income statement will vary depending on the business, but in general, income statements begin with sales, followed by expenses and end with the profits or losses of the business.
Income statements can vary slightly depending on whether the statement is a single-step income statement or multi-step income statement.
To find what is included in a profit and loss statement and how one is formatted, see the items below. Later in this article, you will find an income statement sample.
Note: You may not use all these categories or you may use different categories. For example, if you have a service business, you would probably use Fees Collected or something similar. Use only those categories that pertain to your small business.
Note: See how creating an internal income statement can help you stay on top of your business matters.
Looking for an income statement example to use for your business? Click to download our free Microsoft Excel-based sample income statement template. Our financial statement template allows you full access to the Excel file to change the line item descriptions and is set to automatically tabulate your numbers.
Financial statements are an excellent tool to measure the health of the business. Many of the more powerful formulas use figures from multiple statements but the more common metrics that can be found with the income statement that is used for small businesses include:
The gross margin ratio shows the percentage of sales revenue to be used either as profit or reinvestment and shows the percentage of profit after the cost of goods sold is taken into consideration. This ratio can look at multiple periods to evaluate trends in gross margin and also benchmarked with average industry ratios to see if the business’s ratio is in line with similar businesses. It can indicate pricing may be too low or cost of goods sold are too high.
The profit margin ratio shows the profit per sales dollar after all expenses are deducted from sales. Like the gross margin ratio, the profit margin ratio can be used to identify trends and benchmark against similar industries to see if operating expenses are too high.
The total sales needed to break-even can be determined with the break-even ratio. To calculate, we have to find fixed and variable costs which may take some time. Fixed costs are those costs that don’t vary with sales like rent, telephone, internet, etc. Variable costs, on the other hand, increase when sales increase and decrease when sales decrease. Some examples of variable expenses include sales commissions, direct labor, inventory, etc. Another alternative to variable costing is absorption costing, where all manufacturing expenses are considered part of product costs.
The other number to calculate is contribution margin, which is how much profit is left after taking out the variable expenses to pay for fixed expenses. The contribution margin is calculated by first adding the variable costs and then dividing them by the average selling price. This number is the variable cost percentage. Next, take 1 and subtract the variable cost percentage to find to contribution margin. As an example, let’s say we have a company selling coffee mugs for $1.00 and it costs $.30 to make each mug and the only other variable cost is a sales commission of $.10 per mug and fixed expenses are $250,000.
Step 1: Add variable costs
Total variable costs – $.40
Step 2 – Divide variable costs by average selling price
Step 3 Find the contribution margin
Step 4 Calculate break-even
$250,000 / .6 = $416,667
In this example sales need to be $416,667 in order for the business to break-even.
Even though the income statement is one of the easier statements to review, many people have questions about them. Here are a few of the more common questions.
The first item on a profit and loss statement, which is also called an income statement, is Revenue or Total Sales. Revenue is the total amount of money a business brought in over a particular period of time.
Next will be Cost of Goods Sold, COGS and sometimes direct costs depending on the how accounting is set up. This number shows the costs that were directly related to the sale of that product or service. For instance, a direct cost for a restaurant is cost of inventory, which is the actual cost of ingredients such as lettuce, bread or bacon. Some restaurants will include cooks and food prep wages in as direct labor and some won’t.
Gross Margin is the next line and is calculated by taking Revenue – Cost of Goods Sold.
The next section will be Operating Expenses. Operating Expenses are all of the expenses used to run the business like salaries, rent, utilities, depreciation, etc. The Operating Expenses are separated by category and then tallied as a whole for further calculations.
After Operating Expenses, some other expenses are detailed like interest expense and income taxes to come up with the Total Expenses.
After Total Expenses are figured, they are subtracted from Revenue to find the final number which is Net Profit.
Income statements are used by business owners, accountants, bankers and investors.
The income statement is prepared first because the net income or loss is calculated on this statement and is used on the statement of owner’s equity.
An income statement shows a business’s financial performance, including income and expenses over a particular accounting period typically occurring, monthly, quarterly or annually.
The projected income statement is a statement that estimates the results that you should see from your business, given the current activities. To create a projected income statement, revenues, costs of goods sold, gross profit, and operating expenses are taken into account. A projected income statement differs from a pro forma statement because the pro forma statement makes assumptions on potential outcomes in the future, while a projected income statement assumes that operations will continue as usual
A classified income statement is usually used for more complex businesses and divides revenues and expenses into subtotals to make it easier for users to analyze.
A partial income statement reports information for a part of an accounting period.
The statement of operations is more commonly referred to as an income statement, profit and loss statement or P&L statement.
Income tax expenses can be reported in the operating expenses section as income tax or it can be added after operating expenses as a separate line item before Total Expenses. Income taxes that have accrued and will be paid in the future will show up on the balance sheet as a current liability.
Income tax expenses include local, state & federal taxes charged as a result of a business’s profits.
How do you calculate income tax expense on the income statement?
Divide income tax expense by income earned before taxes. This will show the effective percentage tax rate a business pays.
Now that we have the income statement under control, be sure to look at the other financial statement overviews with the cash flow statement example and balance sheet example too.
