How to Prepare an Income Statement? A Simple 10 Step Business Guide
To prepare an income statement generate a trial balance report, calculate your revenue, determine the cost of goods sold, calculate the gross margin, include operating expenses, calculate your income, include income taxes, calculate net income and lastly finalize your income statement with business details and the reporting period.
To prepare an income statement, small businesses need to analyze and report their revenues, expenses and the resulting profits or losses, for a specific reporting period. The income statement, also called a profit and loss statement, is one of the major financial statements issued by businesses, along with the balance sheet and cash flow statement. Income statements show how much profit a business generated during a specific reporting period and the amount of expenses incurred while earning revenue.
These topics will show you how to prepare an income statement:
How to Write an Income Statement
To write an income statement and report the profits your small business is generating, follow these accounting steps:
1. Pick a Reporting Period
The first step in preparing an income statement is to choose the reporting period your report will cover. Businesses typically choose to report their income statement on an annual, quarterly or monthly basis. Publicly traded companies are required to prepare financial statements on a quarterly and annual basis, but small businesses aren’t as heavily regulated in their reporting. Creating monthly income statements can help you identify trends in your profits and expenditures over time. That information can help you make business decisions to make your company more efficient and profitable.
2. Generate a Trial Balance Report
To create an income statement for your business, you’ll need to print out a standard trial balance report. You can easily generate the trial balance through your cloud-based accounting software. Trial balance reports are internal documents that list the end balance of each account in the general ledger for a specific reporting period. It will give you all the end balance figures you need to create an income statement.
3. Calculate Your Revenue
Next, you’ll need to calculate your business’s total sales revenue for the reporting period. Your revenue includes all the money earned for your services during the reporting period, even if you haven’t yet received all the payments. Add up all the revenue line items from your trial balance report and enter the total amount in the revenue line item of your income statement.
4. Determine Cost of Goods Sold
Your cost of goods sold includes the direct labor, materials and overhead expenses you’ve incurred to provide your goods or services. Add up all the cost of goods sold line items on your trial balance report and list the total cost of goods sold on the income statement, directly below the revenue line item.
5. Calculate the Gross Margin
Subtract the cost of goods sold total from the revenue total on your income statement. This calculation will give you the gross margin, or the gross amount earned from the sale of your goods and services.
6. Include Operating Expenses
Add up all the operating expenses listed on your trial balance report. Enter the total amount into the income statement as the selling and administrative expenses line item. It’s located directly below the gross margin line.
7. Calculate Your Income
Subtract the selling and administrative expenses total from the gross margin. This will give you the pre-tax income. Enter the amount at the bottom of the income statement.
8. Include Income Taxes
To calculate income tax, multiply your applicable state tax rate by your pre-tax income figure. Add this to the income statement, below the pre-tax income figure.
9. Calculate Net Income
To determine your business’s net income, subtract the income tax from the pre-tax income figure. Enter the figure into the final line item of your income statement.
10. Finalize the Income Statement
To finalize your income statement, add a header to the report identifying it as an income statement. Add your business details and the reporting period covered by the income statement.
Income Statement Example
This example of an income statement created by Finance Train can give you a better understanding of what’s reported on an income statement, the format and how the data should be laid out:
What’s the Difference Between a Balance Sheet and Income Statement?
There are a few key differences between the balance sheet and the income statement, including:
- Timing: While the income statement reports financial activity for a specific reporting period, usually a month, a quarter or a year, the balance sheet reports financial activity at a specific point in time, for a snapshot view of a business’s finances.
- Information reported: The income statement reports on a business’s revenues and expenses and ultimately the amount of profit or loss it generated, whereas a balance sheet reports on a company’s assets, liabilities and equity.
- Significance: The income statement is used to report the overall results of the business’s financial performance, or how much earnings it’s generating. The balance sheet is used to analyze whether a company has enough liquid assets to cover its financial obligations.