An income statement is a basic summary of the company’s revenue and expenses within a specified period. While it seems simple enough, they can actually get quite lengthy and hard to read, depending on the nature of your business. Here’s a quick look at how to prepare an income statement that gives insight into your company’s financial activity.
Parts of an Income Statement
A standard business income statement starts with revenue and ends with net income. Revenue is sometimes referred to as the top line, while the net income is known as the bottom line. Expenses and deductions are subtracted from the revenue until you arrive at the net income. The main parts of an income statement include:
- Revenue – revenue refers to the amount the business generates from selling goods or services. It is calculated by multiplying the volume of goods by the selling price.
- Cost of goods sold – This refers to the cost of raw materials needed to produce your goods. For instance, if you resell hardware, the cost of goods sold would be the amount used to acquire the hardware. If you sell services, it would be the labor of the execution team(s).
- Gross profit – Subtracting the cost of goods sold from the revenue gives you the gross profit.
- SG&A – Selling general and administration expenses are all costs not directly associated with producing and selling. It includes rent expenses, marketing, admin wages, etc.
- Depreciation – This is a non-cash expense or provision that allows businesses to claim amounts for their deteriorating assets.
- Operating profit – Subtracting SG&A and depreciation from gross profit gives you an operating profit, which refers to income the business has made from its operations. Operating profit doesn’t include income from financial leverage.
- Interest expenses and tax – Businesses pay interests for both short-term and long-term debts and interest payables. Deduct the interest expenses from the operating profit to get income before tax.
- Other – unusual items either expenses or income, for instance from grants or gains on non-operating activities
- Net income – Also net profit (loss), you arrive at the net income by deducting interests and taxes from the operating profit.
How to Make an Income Statement
Preparing an income statement is best left to experienced accountants that can design the structure of the statement and the accounts in the chart of accounts. The totals shown in each line will depend on the accuracy and completeness of the bookkeeping entries – so this is best left to professionals also. The easiest way to prepare such financial reports is through accounting software. There are three fundamental parts of any income statement: revenue, cost of goods sold and expenses. Accounting software offers robust statements you can use to customize and calculate your income statement.
Why learn how to read an Income Statement
Learning how to read an income statement is just as important as understanding its preparation. The income statement, balance sheet and cash flow are the three reports investors use to determine if a company is worth investing in. You can deduce various things about the business and how it is performing just by looking at the income statement.