How to Put Together an Income Statement
Knowing how to complete an income statement is an essential part of running a successful business. Your company’s income statement calculates your net profit, or bottom line, using this basic formula:
Net profit = Revenue – Costs
The outcome of this calculation gives a measurement of how your company performed financially over a certain time period. The IRS, of course, is interested in your income statement for the taxable year. Seasonal businesses — such as winter ski resorts or summer river-rafting operations for example — view statements quarterly, and many other businesses run reports monthly to keep tabs on their bottom line.
Having a firm understanding of the numbers an income statement contains can help you grasp how to use this information to figure out how your business is performing.
Take a look at how a gift shop called Broad Street Emporium uses income statements to manage business finances. By comparing statements for two years in a row, the owners can see how their financial performance has changed over time.
The Broad Street Emporium income statement includes five sections. Each one provides important information about the company’s financial condition.
Section 1: Gross revenue
The word gross has nothing to do with teenage jargon. In business finance, gross revenue refers to the total of all sales income collected by your business without subtracting any costs.
Depending on your business, your revenue may come from sales of a single product or product line or from a number of different products and services. If you have more than one revenue stream, itemize revenues from each source so that you can see at a glance where your revenue is really coming from and then add the categories to arrive at your gross revenue.
In the case of Broad Street Emporium, gross revenue comes from two major sources: money taken in via in-store retail sales and money collected through the store’s catalog sales.
Section 2: Gross profit
In general, profit is the money that you get to keep after all the bills are paid. Gross profit, also called gross income, is the first stage of profit. It equals gross revenue minus the costs of goods sold, which covers the costs directly associated with producing, assembling, or purchasing what you have to sell.
To Broad Street Emporium, costs of goods sold include the wholesale costs of the merchandise displayed on the gift shop’s shelves and in its catalog. To a service business, costs of goods sold include costs directly related to supplying or delivering the service. To a manufacturer, costs of goods sold include costs for raw materials and the labor, utilities, and facilities needed to put the product together.
Section 3: Operating profit
After you have subtracted your costs of goods from your gross revenue to arrive at your gross profit, the next step is to calculate your operating profit (also referred to as the operating income or EBIT, which stands for earnings before income and taxes).
To figure your operating profit, follow these steps:
Subtract from your gross profit your operating expenses.
Operating expenses, also know as general and administrative expenses or SG&A (sales, general, and administration expenses), include the costs involved in operating your business, including salaries, research and development costs, marketing expenses, travel and entertainment, utility bills, rent, office supplies, and other overhead expenses.
Account for something called depreciation expenses.
When you purchase big-ticket items for your business — maybe a car to call on clients, a computer system, or even a building for offices, warehouse space, or other facilities — what you’re really doing is exchanging one asset for another asset.
The business assets you acquire all have useful life spans, so one way to spread out the costs of these assets over the number of years they’re actually in service is to calculate and deduct depreciation expenses each year.
Subtract your operating and depreciation expenses from your gross profit.
Operating profit = Gross profit ‒ Operating expenses and Depreciation expenses
On the Broad Street Emporium income statement, operating expenses reflect staff salaries, advertising costs, and production and delivery of the store’s catalog three times a year. In addition, the company takes depreciation expenses for its storefront building, computer system, and delivery van.
When calculating your operating profit, watch your overhead expenses like a hawk. If they get out of line, they can quickly eat away at your gross profits.
Section 4: Profit before taxes
Profit before taxes takes into account any income that your company made on investments of any sort and subtracts any interest expenses you paid over the statement period.
Profit before taxes = Operating profit + Investment income – Interest expenses
The reason that you keep investment income and interest expenses outside your operating profit is because they result from money management and aren’t really part of your business operations. For one thing, the amount of interest you pay depends on how you’ve structured your company financially. For another thing, interest absolutely, positively has to be paid on a strict and unforgiving schedule.
Section 5: Net profit
Net profit (also called net earnings, net income, or bottom line) is what’s left after you subtract your final expenses from your total business income. As you read that sentence, you’re probably thinking, Final expenses? We’ve already deducted every cost under the sun. What’s left to subtract? How about taxes?
Depending on how you structured your company, your business may or may not pay taxes directly on its profits. If you’re a sole proprietor or if your business is a partnership, for example, your profits are funneled straight to the owners for tax purposes. But if your business pays taxes, you need to subtract those taxes before you state your final profit.
After Broad Street Emporium paid its taxes for the year, the business was left with a net profit of $92,000. That’s good news because it amounts to a 21 percent increase over the previous year.