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How to prepare an income statement

Along with the balance sheet and the cash flow statement, the income statement is one of the most important financial documents produced by your business. But what is an income statement? Find out everything you need to know about the format of an income statement with our comprehensive guide. We’ve also put together an income statement template so that you can see how this type of financial document works in the real world.

What is an income statement?

Income statements, also referred to as profit and loss (P&L) statements, provide a summary of your company’s income and expenses over a specific period. It includes revenue, expenses, gains, losses, and the resulting net income from the period the statement covers. In other words, the income statement helps you to understand whether your business has made a profit or a loss. This can give you an excellent insight into your firm’s financial health over a given period.

What do you need to include in an income statement?

Income statements include a broad range of items, including revenue, expenses, cost of goods sold (COGS), operating income, gross profit, income before taxes, net income, earnings per share (EPS), depreciation, and earnings before interest, taxes, depreciation, and amortization (EBITDA). In many cases, this financial data will be divided into individual line items to improve the granularity of your reports. For example, expenses may be broken down into wages, procurement costs, etc.

Income statement vs. balance sheet

When it comes to income statements vs. balance sheets, there are a couple of clear differences. Whereas the income statement records your income and expenses, the balance sheet covers your business’s liabilities, assets, and equity. It’s also important to remember that income statements cover a specific period. In contrast, the balance sheet provides a snapshot of what your business owns and owes at a single point of time.

Income statement example

Now that you know a little more about income statements, it may be beneficial to explore the format of an income statement in more depth. To do that, we’ll need to see an income statement example. Here’s an income statement template for a fictional company:

Company A

Income Statement

For Year Ending December 31, 2020

Net Sales – $400,000

Cost of Sales – $150,000

Gross Profit – $250,000

Selling and Operating Expenses – $90,000

General and Administrative Expenses – $45,000

Total Operating Expenses – $135,000

Operating Income – $115,000

Other Income and Expenses – $75,000

Income Before Tax – $190,000

Income Tax (35%) – $66,500

Net Income – $123,500

There are plenty of other income statement examples available online. Check out this example of an income statement template for one year from Microsoft Office.

How to create an income statement

Knowing how to prepare an income statement is crucial. While you can use an income statement template, as above, it may also be a good idea to explore how to prepare an income statement by hand. Here’s a simple, step-by-step guide:

  1. Select a reporting period – Firstly, you’ll need to select the period you want the income statement to cover. Most of the time, income statements are produced on an annual, quarterly, or monthly basis. Creating monthly reports can help you identify trends on a granular level and improve your profits/expenditures.

  2. Produce a trial balance report – Next, you should prepare a trial balance report (an internal document listing all the account balances in your general ledger). Generally, you should be able to generate these reports using your accounting software.

  3. Work out your revenue – Now, it’s time to work out your business’s revenues. To do this, add up the revenues from your trial balance report and enter the final amount in the revenue line item.

  4. Calculate the cost of goods sold – It’s also essential to determine the cost of goods sold, a figure which includes materials, direct labor, overheads, and so on. Add up all the amounts from your trial balance report and list them in the COGS line item.

  5. Work out your gross margin – Subtract the cost of goods sold from revenue to work out your gross margin.

  6. Add your operating expenses – Once again, you’ll need to add up all the operating costs included in your trial balance report. This item is usually split up into selling and operating expenses and general and administrative expenses.

  7. Calculate your income – Work out your income by subtracting your operating expenses from your gross margin.

  8. Add your income taxes – Now, after you’ve factored in any other income streams, it’s important to apply income tax to find out how much money you’ll actually be left with.

  9. Determine your net income – Finally, you can determine your net income by subtracting your income tax from your pre-tax income.

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