What is an income statement?
An income statement reports a company’s net income for a specific accounting period, which is calculated using its total revenue and total expenses. Also known as a profit and loss statement or a statement of revenue and expenses, the income statement is one of three financial statements companies use to monitor their performance over a period of time. The other two are the balance sheet and the cash flow statement.
The time frame of the accounting period being examined is indicated at the beginning of the income statement. This is different than a balance sheet, which reflects a picture of a company’s financials at a specific date. Many companies will produce these reports monthly for internal purposes, and then produce quarterly and annual summaries for external uses.
Items included on an income statement
The income statement is made up of four components:
Each of these sections is used to determine a business’ net income, which is essentially how much money is left over after all business expenses have been accounted for. Formulaically, this is how net income is calculated:
Net income = (Total revenue + gains) - (Total expenses + losses)
Revenue and gains
Revenue and gains can generally be classified into the following streams:
Operating revenue: This is collected from all activities directly related to the core function of a business, e.g. the payment a dance studio collects fees from its class attendees or a technology company gathers payments from people who purchase its software.
Non-operating revenue: This is derived from other business activities that don’t sit at the center of a company’s purpose, such as rent accrued from leasing company buildings.
Gains: Similar to non-operating revenue, this figure is accrued from secondary transactions. The difference, however, is that activities labeled as ‘gains’ are singularly-occurring events. An example of a gain is the excess amount made from the sale of an old building that the business no longer uses.
It’s important to note that revenue and receipts are two distinct financial categories. While revenue is accounted for on the income statement for the period in which the product was sold or the service rendered, a receipt is only marked when the payment actually occurs (and therefore, in the meantime it’s recorded on the balance sheet instead).
That could mean that a large order of paint for a trusted client is counted in the first quarter income statement for a manufacturer, yet the receipt of payment doesn’t happen until the second quarter when the order is delivered.
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Expenses and losses
In contrast to revenue and gains, expenses and losses signify the amount of money a company puts towards what it needs to function on a day-to-day basis and generate a profit. These components mirror revenue and gains in many ways.
Operating expenses: Amount a business spends to sustain the daily needs of its operations, such as staff salaries or monthly utility bills.
Non-operating expenses: Amount spent on business needs not related to the core company product or service, such as interest on a loan.
Losses: Money spent on a unique, secondary activity expense. Lawsuits are a common example of a loss, as they are not integral to the main operations of the company nor are they recurring expenses.
Multi-step versus single-step income statements
In a multi-step income statement, both operating and non-operating revenue and expenses are tracked separately. On a single-step income statement, these streams are blended to reflect just the more generalized categories of revenue and expenses.
The purpose of an income statement for your business
There are many reasons why companies prepare income statements when starting a business and scaling one. Some primary reasons include:
Filing taxes properly
As an internal tool for measuring profit and guiding strategic business decisions
Proof of financial soundness to external stakeholders, including investors
An income statement should be a key part of your bookkeeping plan.