From learning about 1099 Forms, picking up bookkeeping tips, and figuring out how to calculate a cash flow analysis, it’s easy to feel overwhelmed when starting your own business.
But this is your dream and you shouldn’t need to have an advanced degree in accounting to take control of your business’s finances. So let’s start with the basics.
In this article, we’ll take you through a very important part of running a business, income statements. This is one of three important financial documents that you’ll want to become familiar with — the other two are a balance sheet and a statement of cash flows.
What is an Income Statement?
An income statement, also known as the profit and loss statement, is a financial document that’s important to managing your small business’s financial health. This statement is used to report your revenue, expenses, and profits and losses over a set period of time. The income statement provides you and your accountant with a summary of your finances across the following categories:
- Cost of goods sold (COGS)
- Gross profits
- Operating income
- Net profit
Income Statement versus a Profit and Loss Statement
If you’re new to owning a business, managing both your operations and your small business’s banking can sometimes feel like choppy waters to navigate. If you don’t have a degree in financing (most small business owners don’t) some jargon can get the best of you. That’s okay! That’s where we come in.
You will most likely see the term “income statements” and “profit and loss statements” used interchangeably, and this is because the two are in fact the same. So don’t panic if someone asks about one and you’ve only got the other! You’re good to go, we promise.
What does an Income Statement Tell You About Your Business?
The income statement reports information about your small business’s net profit. This is based on the revenues and expenses reported in the statement. How valuable is this information? It helps a business better understand the following:
- Budgeting — here to cut costs and how to drive revenue through budgeting readjustments
- The cash flow of your business
- Revenue and loss trends
These insights can help you develop actionable plans to grow your business’s profitability.
What is Included on an Income Statement?
When putting together your business’s income statement, include the following categories:
- Revenue: This refers to money made from selling your service or product, and non-operating income from sources like investments.
- Cost of Goods Sold (COGS): The amount of money needed to provide your service or product.
- Gross Profit: The product of subtracting your COGS from your net sales (money earned from your product or service).
- Expenses: This refers to operating expenses. This is money you’ve invested in the function of your business, such as administrative costs, rent, payroll, or utilities.
- Operating Income: The profit earned from ongoing operations. This is the product of taking your gross profit and subtracting all of your operating expenses.
- Net Profit: Total money your business earned after you deduct expenses. This is the product of taking gross profit and subtracting total expenses.
Single-Step vs. Multi-Step Income Statement
The single-step approach is simple. This approach takes revenue and subtracts expenses to equal net income. The single-step approach lumps all the revenues into one figure and the expenses into one figure to use one simple equation to make the process more streamlined.
The multi-step income statement is a method of creating your financial statement using four critical areas of your business’s operations: gross, operating, pretax, and after-tax. The multi-step approach first takes operating expenses from the gross profit to find operating income. Then additional revenues are added while expenses are subtracted to find income before taxes. Lastly, taxes are deducted in order to find net income.
There you have it, a crash course on the income statement. Check out our post on profit and loss statements (see, told you you’d see them used interchangeably!) for more information on how to put together this document.