Income Statement

The income statement is the determination of a company's success within a given period. Since the definition of success fundamentally depends on the company's objectives, the metrics used in the income statement are not rigidly prescribed. Generally speaking, in the income statement, expenses are compared against revenue. The difference (balance) from this comparison shows whether your company has achieved a profit or loss. The income statement thus reveals how successful your company was in a specific period (typically a fiscal year).

What Is a Profit and Loss Statement?

A profit and loss statement is a financial report that shows a company's revenue and expenses. It also shows whether a company made a profit or loss in a given period. Together with the balance sheet and the cash flow statement, the profit and loss statement helps you understand the financial health of your business. The profit and loss statement is also known as the income statement, statement of operations, statement of financial results, or earnings statement.

The Importance of a Profit and Loss Statement

A profit and loss statement helps business owners decide whether they can achieve results by increasing revenue, reducing costs, or both. It also shows the effectiveness of the strategies that the company established at the beginning of a financial period. Using this document, business owners can determine whether their strategies have paid off. Based on their analysis, they can find the best solutions to generate more profit.

Why Is the Profit and Loss Statement So Important?

In the business world, preparing a profit and loss statement is a monthly, quarterly, and even annual matter. Here are some good reasons why preparing a profit and loss statement is such an important task in every company, regardless of size:

• Better decision-making – Reading the profit and loss statement enables business owners to stay informed about the company's current financial situation. With the precise figures in the profit and loss statement, business owners can make quick and smart decisions about the company's spending. This also enables them to identify and fix small business problems before they become large and expensive.
• Track the profitability of the business – With a profit and loss statement, the business owner, shareholders, and stakeholders get an overview of the financial situation, for example the return on sales of the company.
• Accurate determination of expenses – This statement highlights the company's future or unexpected expenses as well as any areas that are over or under budget. Expenses include building rent, salaries, and other overhead costs. When a small business begins to grow, its expenses can skyrocket. These expenses may include hiring employees, purchasing supplies, and advertising the business.
• Essential report for compliance – If you operate your business in a country, you must pay the various forms of corporate taxes while observing the tax regulations of the respective country. Paying corporate taxes is a legal requirement. To calculate your tax liability, the profit and loss statement and other financial reports (balance sheet and cash flow statement) are very helpful, as they provide the necessary financial data.
• Overall analysis of the business – This statement gives investors an overview of the company they intend to invest in. Banks and other financial institutions can also analyze this document to decide whether the company is creditworthy.

Types of Profit and Loss Statements

Single-Step Profit and Loss Statement

This is a basic report on a company's profit, created using a single equation to calculate net income.

Net Income = (Revenue + Gains) - (Expenses + Losses)

Multi-Step Profit and Loss Statement

A three-step process is used to calculate net income, separating operating revenues and expenses from non-operating ones.

Gross Profit = Net Sales - Cost of Goods Sold Operating Income = Gross Profit - Operating Expenses Net Income = Operating Income + Non-Operating Items

How to Create an Income Statement

To create a profit and loss statement, it is best to use financial tools, such as liquidity planning software or cash flow software. With these, you go through the following process:

Screenshot: finban.io

1. Reporting period – To create a profit and loss statement, we must first establish a specific time period for the statement. The period can be on a monthly, quarterly, or annual basis. Publicly traded companies typically prepare an annual profit and loss statement, while smaller companies tend to create a monthly or quarterly report.
2. Trial balance report – Once you have established the reporting period for your profit and loss statement, you need a trial balance. This report contains the ending balance of each account and the figures needed to prepare a profit and loss statement. There are financial tools, such as finban.io, that allow you to view different accounts on an accumulated basis.
3. Revenue – The equivalent value that flows to a company in the form of cash or receivables through the sale of goods or services.
4. Cost of Revenue (COGS / Cost of Revenue) – The costs directly associated with selling a service or product.
5. Gross Profit (Gross Profit) – Subtract the cost of goods sold from your revenue, and you get the gross profit.
6. Operating Expenses – The costs incurred to run the business. These are deducted from gross profit, and we get income before taxes (operating profit).
7. Operating Profit (Income Before Taxes) – Subtract cost of revenue and operating expenses from gross profit to determine your pre-tax result.
8. Net Income – Subtract all expenses from your gross profit, including wages, taxes, and COGS. This gives you the net profit.