An income statement, also known as a profit and loss statement (P&L statement), summarizes a business’s revenues and expenses over a period of time. It’s one of the most important financial statements for small business owners, so it’s key to understand what an income statement is, what its purpose is, and how to read one.
The hardest part? Knowing where to start, especially if you’re not a “numbers person.”
Luckily, we’re here to define what an income statement is and give a few examples of how small business owners can use them to make smart business decisions. By the end of this post, you’ll feel like an accounting pro. 😎
What is an income statement?
An income statement is an important financial statement that gives you a look into your business’s financial health and profitability for a specific period.
An income statement is one of three key financial statements for small business owners—the other two being your balance sheet and your cash flow statement. The income statement is the most important of the three (but don’t tell the others we said that).
With all three documents in hand, you’ll be able to determine whether you’re profitable or not—which investors will want to know, too!
What’s the purpose of an income statement?
Okay, we’ve made a bit of a fuss about income statements so far, so at this point you’re probably wondering: Why are income statements so important, anyway?
The main thing you can learn from an income statement is how much money your business earned, and how much money your business spent to earn it. Your income statement lets you see your business’s financial health, so you can set realistic and helpful goals and budgets for the future—and see if those efforts have been successful.
Using your learnings from an income statement, you can determine whether to expand your business, increase production, or, on the other hand, stop producing certain products or investing in specific parts of your business that might not have the best return on investment.
Who uses an income statement?
Your income statement can be used both internally by you and anyone else within your business, or externally by stakeholders.
For example, business managers, your board of directors, or simply just little ol’ you would use your income statement to evaluate your business’s performance and make decisions.
External stakeholders—like investors or creditors—will want to evaluate your income statement before deciding to work with you. The Internal Revenue Service (IRS) will also need to see an income statement to determine your total taxable business income.
The income statement vs. the balance sheet
Like an income statement, a balance sheet also gives you a look into your business’s finances for a specific period of time. However, balance sheets are usually for a specific date, while income statements are for longer periods, like a month, quarter, or year.
While your income statement shows you how profitable your business is, your balance sheet shows you how many assets you have, how much you owe others, and—ultimately—how much you have at the end.
For a deeper dive into how to prepare financial statements, like an income statement and a balance sheet, check out our video on bookkeeping! The five bookkeeping steps we go over will help you get the most out of your income statement, and beyond.
What goes on an income statement?
Important note before we get into the components of an income statement: make sure you choose an accounting method first, and stick with it! Your accounting method will determine how you calculate your revenue, so you need to stay consistent.
If you’re using accrual-basis accounting, you’re reporting on revenue and expenses that haven’t yet been received or paid.
And if you’re using cash-basis accounting, you’re reporting revenue and expenses only when they have actually been received or paid.
Okay, caveat over. Let’s get into the five key parts of a standard income statement, and how you can prepare an income statement yourself. Buckle up!
Your revenue (aka income) is how much money your business earns from goods and services. This includes “operating” revenue, which is the revenue you make from selling goods and services, and “non-operating” revenue, which you make through behind-the-scenes operations, like maintenance.
To find your revenue, list out and add up your total income from goods or services. If you sell multiple goods or services, you can organize your sales by subcategory.
Cost of goods sold (COGS)
Cost of goods sold (COGS) is how much it costs your business to make the products or deliver the services you sell. COGS only refers to direct expenses (think: purchasing inventory or raw materials). To get your COGS, list out and add the total costs that are directly related to your goods/services.
Equation time! Gross profit is your revenue or income minus the COGS. At this point, your gross profit will tell you how profitable your business is, with only direct expenses being considered.
Operating expenses are expenses for your business that aren’t directly part of the costs of a product or service. These can include payroll, rent, interest, insurance, Internet, and more. Again, it might be helpful to create categories for each type of these costs.
Now, take your gross profit and subtract operating expenses, and you’ll get your net profit—aka your “bottom line.” Yay!
With net profit, you’ll be able to answer key questions, like: Is your business making or losing money? And can you really afford that new coffee machine for your office this year?
How to prepare an income statement
Next, let’s bring all this info together and walk you through how to prepare an income statement.
- At the top of the report, start with income (aka “revenue”).
- Next, add up your cost of goods sold.
- Now, take the income amount and subtract the cost of goods sold to get the gross profit number.
- Below that, add up your operating expenses.
- And finally, we take the gross profit and subtract the operating expenses to get the net profit.
Psst—you can easily generate an income statement using Wave’s accounting software!
For a more in-depth look into how to prepare an income statement, we have an entire video on income statements (remember, an income statement is also called a “profit and loss statement”!) below.
How to read an income statement
Okay, so now you have a nifty income statement. But what can you learn from it?
For an income statement of a specific timeframe, there are some key learnings you can get, including:
- How much your business earned from sales
- How much your business spent on expenses
- How profitable your business is
- Where you can reduce expenses to become more efficient
Building income statements monthly and reviewing them over time helps you understand long-term trends like:
- Whether your business is becoming more profitable
- How your sales are changing
- How your expenses are changing
- Whether you’re becoming more efficient with your business expenses versus your business income
All of these learnings—both on their own and together—can help you make smart money decisions as a business owner.
Generate an income statement today!
We made it! Be sure to bookmark this blog and use it as a jumping off point to:
- Build income statements on a regular basis
- Analyze the findings and make decisions to keep your business happy and healthy
And remember, you can easily generate income statements using accounting software, like Wave’s, saving you major time and headaches.
No matter what you choose, we know you’ll rock your next income statement.
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