An income statement or a profit and loss statement, reports the changes in income and expenses over a period of time, usually monthly, quarterly or yearly. This financial statement is important because it shows the profitability of your business. This post will help you understand the two different kinds of income statements and how to properly create them.
It’s important to note that the income statement doesn’t show cash receipts or cash disbursements. Also, it uses the concept of accrual accounting. This means revenues and expenses match perfectly with the period in which they occur, not necessarily when the payments are made or received.
There are three aspects to the income statement: revenues, operating expenses, and net income. However, this can vary according to the complexity of your business. You can create a single-step income statement or a multiple-step income statement.
Single-Step Income Statement
Revenues and gains
The statement typically starts with “revenues and gains” at the top. Within this section you should record your revenue from operating activities, revenue from non-operating activities (such as interest), and gains from the sale of assets. Gains are calculated as the difference between what was received from the sale and the book value of the item sold. You receive gains when the proceeds are higher than the book value.
The next section records expenses. This section includes all expenses incurred in order to earn operating revenue, non-operating expenses (interest), and losses. Losses are the opposite of gains, and refer to the loss from the sale of an asset.
Net income/net loss
The last section of the income statement shows the net income or net loss. This number is calculated by subtracting total expenses from total revenues. Net income represents a profit generated during the time period. If the net income is a negative number, then your business experienced a loss.
Multiple-Step Income Statement
This formatting is an alternative to the single-step statement, and it uses multiple subtractions when calculating the net income. The three aspects are the same, however they are organized and calculated a bit differently and a few aspects are added.
The multiple-step statement creates two sections for operating revenue and operating expenses and also incorporates gross profit. Gross profit is equal to net sales minus the cost of goods sold.
In order to calculate operating income, operating expenses is subtracted from gross profit. We don’t see operating income on the single-step statement so that is one benefit of using the multiple-step statement.
All non-operating revenues, gains, non-operating expenses and losses are combined in one section and added to operating income to get the net profit or loss. Non-operating expenses are expressed in parentheses to show they are negative numbers.
Learn more about cash flow and how to set appropriate goals in our free ebook: The Ultimate Guide to Accounting For Startups.