What is an Income Statement?

The income statement, also known as the profit and loss (P&L) statement, is one of the key financial statements in bookkeeping. It helps companies evaluate performance by tracking gains and losses over a set period of time. 

What is an Income Statement?

There are two account categories in double-entry bookkeeping. The first is permanent accounts (assets, liabilities, and equity), which represent ongoing financial progress through cumulative balances. The second is temporary accounts (expenses and revenue), which represent a company’s activity over a given accounting period and thus reset balances per new period. 

The income statement takes the balances of expense and revenue accounts to represent earnings and expenses over the selected accounting period. 

What is an Income Statement for?

The income statement illustrates financial performance over a specific timeframe, which is usually one accounting period. It shows the effectiveness of revenue-generating activities by comparing a company’s earnings to its related expenses. 

Companies often compare their income statements with competitors to assess where they stand in the industry. They also compare income statements generated across multiple accounting periods to evaluate the impact of business strategies or seasonal changes on earnings and revenue. Collecting income statements long-term helps you spot revenue and expense trends. 

For example, a company that started a marketing campaign in February might review January and February income statements to determine the campaign’s effect on profitability. A company preparing to cut costs during winter might analyze the previous winter’s income statement to forecast future expenses. 

The income statement also helps attract investors. The information on the income statement allows you to calculate earnings per share and price-per-earnings ratios, which helps investors determine whether your company can provide adequate returns on their investments. 

How to Prepare an Income Statement

Preparing your income statement should be a simple process if you maintain accurate books. You only need to identify an appropriate reporting period and transfer information from your ledger to your report. 

1. Select a Reporting Period

The first step in preparing your income statement is selecting an appropriate reporting period. Typically, companies will report their income statements on a monthly, quarterly, or yearly basis.

  • Monthly: The more frequently you generate income statements, the better equipped you are to identify trends in earnings and expenses. Reporting monthly also helps you gauge the impact of short-term business decisions. 
  • Quarterly: Publicly traded companies are required to report financial statements on both a quarterly and yearly basis. Additionally, reporting income statements quarterly helps you spot seasonal trends. 
  • Yearly: As mentioned, publicly traded companies are required to report financial statements on both a quarterly and yearly basis. Yearly income reports help you assess the overall impact of all business strategies implemented each year. 

2. Gather Relevant Documents

Once you’ve identified a reporting period, gather all relevant documents. The most important document is your general ledger because it documents all revenue and expense transactions incurred in your selected reporting period. 

You should also gather general journal entries and other bookkeeping journals, receipts, and invoices to confirm the validity and existence of all transactions recorded in your ledger. 

3. Validate Accuracy with a Trial Balance

A trial balance is a worksheet that helps you confirm whether records on the general ledger are accurate. It lists the debits and credits of all accounts to confirm adherence to the accounting equation. If debits and credits are equal, your books are accurate. You can move revenue and expense information to your reports. 

4. Select Between Single- or Multi-Step Income Statements

The final step is selecting between reporting income through the single or multi-step method. The single-step method suits sole proprietors and small businesses with lower transaction volume. Meanwhile, the multi-step method provides more details and suits larger businesses. We provide more information and preparation guidelines below. 

Single-Step vs Multi-Step Income Statement 

There are two main ways to present income statements. Single-step income statements are easier to prepare but provide fewer details, while multi-step income statements offer comprehensiveness at the cost of complexity. 

Single-Step Income Statement 

Single-step income statements present earnings and expenditures as four distinct categories: revenue, expenses, gains, and losses. 

  • Revenue: The money earned over a given accounting period
  • Expenses: The money spent to support business operations
  • Gains: Increases in asset value incurred from activities outside of core business operations. Examples include the sale of assets, lawsuits, and investments in securities. 
  • Losses: Decreases in asset value incurred from activities outside of core business operations. Examples include settlements and losses from investments. 
  • Net Income: The earnings a business generates after subtracting expenses, interest, taxes, and losses. One of the formulas for net income is (Revenue + Gains) – (Expenses + Losses).
Example Co. 
Income Statement
For the month ended December 31, 2024
RevenueMerchandise Revenue$5,000
Revenue from Services$12,000
  
Net Sales$17,000
ExpensesCost of Goods Sold$2,500
Wage Expense$9,000
Rent Expense$2,000
Utilities Expense$500
  
Total Expenses$14,000
GainsIncome from Sale of Equipment $1,000
LossesSettlement Loss$300
Net Income $3,700

The above example placed all related revenues and expenses in their corresponding categories, and then generated the sum of each category. Plugging the values into the net income formula, they got:

(Revenue + Gains) – (Expenses + Losses) = Net Income

($17,000 + $1,000) – ($14,000 + 300) = $3,700

The single-step income statement is suitable for sole proprietorships and very small businesses. However, larger businesses might need more detail. 

Multi-Step Income Statement 

Multi-step income statements report income at five levels: net sales, gross profit, operating income, pretax income, and after-tax income. It also consists of major expense and revenue categories, such as cost of goods sold, operating expenses, and non-operating revenue and expenses. 

Expense and Revenue Categories

  • Cost of Goods Sold: The cost of goods sold refers to the overhead costs associated with creating a product or service. These include materials, packaging, and direct labor.
  • Operating expenses: Operating expenses refer to the costs of running a business. These can include rent, utilities, marketing, wages, and equipment. 
  • Non-Operating Revenue and Expenses: Non-operating revenue and expenses include all earnings and costs incurred outside of core business operations. Examples include the sale or purchase of investments, stock-based compensation, and settlement winnings or dues. 

Income Levels

  • Net Sales: Net sales, also known as total revenue, is the sum of all earnings generated by core business activities. 
  • Gross Profit: Gross profit refers to the difference between total revenues and the cost of goods sold. 
  • Operating Income: Operating income, or operating profit, refers to the difference between gross profit and operating expenses.
  • Pre-tax Income: Pretax income subtracts all non-operating expenses (except tax) from operating income. 
  • After-tax Income: Finally, after-tax income is total revenues minus the cost of goods sold, operating expenses, and non-operating expenses. 
Example Co. 
Income Statement
For the month ended December 31, 2024
Net Sales$17,000 
Cost of Goods Sold($2,500) 
   
Gross Profit$14,500
  
Operating Expenses 
   Salaries($9,000) 
   Rent($2,000) 
   Utilities($500) 
  
Total Operating Expense($11,500) 
  
Total Operating Income$3,000
  
Non-Operating Revenues and Expenses 
   Gain on sale of asset$1,000 
   Loss on settlement($300) 
  
Total Non-Operating Revenues and Expenses$700 
  
Net Income Before Taxes$3,700
Income Tax Expense($50)
Net Income  $3,650

As shown above, generating a multi-step income statement involves the following steps:

  1. Subtract the cost of goods sold from total revenue to generate gross profit.
  2. Add up all operating expenses. Subtract operating expenses from gross profit to get operating income.
  3. Add up all non-operating revenues and subtract all non-operating expenses. Subtract the result from operating income to get net income before taxes.
  4. Subtract net income before taxes to get after-tax net income. 

While more complex than the single-step income statement, the multi-step income statement provides more visibility into the different levels of profitability. It shows you how much of your revenues are allocated to different business requirements, namely cost of goods sold, operating expenses, non-operating expenses, and tax. 

The added visibility allows you to analyze your financial situation better. For example, a cost of goods sold that takes up a huge percentage of your net sales implies you’re not charging high enough margins. If you can neither lower your cost of goods sold nor increase your selling price, you might need to lower operating expenses to remain profitable. 

Because the multi-step income statement is more comprehensive, it is popular among large businesses. However, smaller businesses might find it too time-consuming. 

How to Evaluate Income Statements

There are multiple ways to analyze your income statements. Most evaluation methods involve comparing past income statements with current income statements to gauge progress, or company income statements with competitor statements to gauge relative performance. Below are a few metrics you can use to evaluate income statements. 

MetricFormula
Gross Margin(Net Sales – Cost of Goods Sold) / Net Sales
Operating Margin(Net Sales – Cost of Goods Sold – Operating Expenses) / Net Sales
Net Profit MarginNet Income / Net Sales
Earnings Per Share(Net Income – Preferred Dividends) / Weighted Average Number of Shares Outstanding
Price-to-Earnings (P/E) RatioShare Price / Earnings Per Share
Revenue Growth Rate(Current Revenue – Previous Revenue) / Previous Revenue 

Gross Margin 

Gross margin is the ratio of gross profit to net sales. It tells you how much revenue remains after subtracting the overhead costs of creating a product. Higher gross margin ratios mean more revenue left over for operating expenses, reinvestments, or profit. 

Formula: 

  • (Net Sales – Cost of Goods Sold) / Net Sales OR
  • Gross Profit / Net Sales

For example, if net sales amounted to $5,000 in one month, and the corresponding cost of goods sold was only $1,000, your gross margin would amount to $4,000/$5,000, or 80%. This means that you keep 80 cents per dollar of sales. 

Operating Margin 

The operating margin is the ratio of operating income to net sales. This shows you how much revenue remains after subtracting overhead costs and operating expenses. Like with gross margin, a higher operating margin means more funds are available for reinvestments and profit.

Formula: 

  • (Net Sales – Cost of Goods Sold – Operating Expenses) / Net Sales OR
  • (Gross Profit – Operating Expenses) / Net Sales OR
  • Operating Income / Net Sales

If net sales in one month amounted to $5,000, and the corresponding cost of goods sold and operating expenses amounted to $1,000 and $2,500, respectively, your operating margin would amount to $1,500/$5,000, or 30%. This means that you keep 30 cents per dollar of sales revenue. 

Net Profit Margin 

The net profit margin, or simply the profit margin, is the ratio of net profit to net income. It tells you how much revenue is left over after subtracting all expenses, including cost of goods sold, operating expenses, non-operating expenses, and tax. 

Formula: 

  • (Net Sales – Cost of Goods Sold – Operating Expenses – Non-operating Expenses – Income Tax) / Net Sales OR
  • Net Income / Net Sales

Because it accounts for all possible spending, it is one of the most effective ways to measure profitability. 

Let’s say you generated $5,000 in total monthly sales revenue and incurred the following expenses:

  • Cost of goods sold worth $1,000 
  • Operating expenses worth $2,500
  • Non-operating expenses worth $50
  • Income tax worth $150

This yields the following results:

  • Gross profit worth $4,000
  • Operating income worth $1,500
  • Pre-tax income worth $1,450
  • Net income worth $1,300

You would end up with a profit margin of 26%, which means you keep 26 cents per dollar of sales earned.

Earnings Per Share (EPS)

Earnings per share calculates the ratio between earnings remaining after preferred dividends and the average number of shares outstanding. Companies with high EPS are attractive to investors because they generate more profit per share of stock. 

Formula: (Net Income – Preferred Dividends) / Weighted Average Number of Shares Outstanding

Let’s say your company generates a profit of $20 million per year. It rolls out $2 million in dividends to holders of its preferred stock. With a weighted average number of shares outstanding of $10 million, it has an earnings per share of $1.8. This means the company generates $1.8 in profit per available share. 

Price-to-Earnings (P/E) Ratio

The price-to-earnings (P/E) ratio is one of the most popular metrics used in evaluating investment potential. It shows investors how much money they pay per dollar a company earns. The ratio helps investors determine whether a company is under or overvalued. 

Formula: Share Price / EPS

Higher P/E ratios indicate that investors must pay higher prices for company earnings, while lower P/E ratios indicate the opposite. 

Let’s say you sell your shares at $36 each. With an EPS of $1.8, you have a P/E ratio of 20. This indicates that investors are willing to pay $20 per dollar the business earns. 

Revenue Growth Rate

The revenue growth rate compares your current revenue to your previous revenue. It helps you assess the effectiveness of your growth initiatives. 

Formula: (Current Revenue – Previous Revenue) / Previous Revenue 

Alternatively, the metric can help you determine the impact of external factors on revenue.

Let’s say your total revenue was $5 million in 2023 and $7 million in 2024. Your growth rate would be $2 million divided by $5 million, which indicates that the company grew its revenue by 40%.

There is no standard metric for assessing the efficiency of revenue growth. Typically, companies will compare their revenue growth rate against set targets, previous growth rates, or competitor growth rates.

Outsource Financial Reporting to EpicBooks

The income statement is an indispensable financial report that helps you assess the effectiveness of your revenue-generating activities over a designated period of time. An accurate income statement can help you gauge financial performance, make smarter business strategies, and attract potential investors.  

The burden of bookkeeping can steal time from your core business activities. If you want to dedicate all your focus to managing your business, consider outsourcing financial tasks to the experts. The professionals at EpicBooks can generate insightful financial statements, keep accurate records, and provide financial advice that helps you thrive in the Canadian business market. 

We focus on your statements so you can focus on success. Read the EpicBooks services page for more information. 

FAQs

What is the difference between the profit and loss statement and the income statement?

Profit and loss statement is another name for income statement. There are no differences between the two financial statements. Other names include earnings statement, expense statement, operating statement, and statement of financial results. 

What is the difference between the cash flow statement and the income statement?

The cash flow statement tracks the movement of cash and cash equivalents over a given period of time. Meanwhile, the income statement tracks revenue, gains, expenses, and losses. Because there is often a time gap between incurred transactions and their corresponding cash payments, creating a separate financial statement for cash flow is necessary for tracking a company’s efficiency in converting revenue to usable cash. 

What is the difference between the balance sheet and the income statement?

The balance sheet tracks permanent accounts, such as assets, liabilities, and equity. Because these accounts have cumulative balances, they help companies track ongoing financial progress, providing a snapshot of everything owed and owned at a given point in time. 

Meanwhile, the income statement tracks the temporary accounts, expenses, and revenue. It resets balances per accounting period and shows all earnings and expenses within a given timeframe. 

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