Small business owners are often intimidated by having to create a traditional income statement for their company. However, it doesn’t have to be that way.
All of your financial statements are valuable for helping you run your business. They give you insights into how your money is doing and whether or not there are potential problem areas to address.
The income statement, though, is probably one of your key financial documents. By using it well, you can have incredible knowledge that gives you peace of mind and helps you make smart decisions for your company.
What is a Traditional Income Statement?
A traditional income statement (also known as a “profit and loss statement”, or “P&L”) is a fairly simple report that shows your company’s revenue and expenses for a particular period of time. It shows whether or not it made a profit during that time or is operating at a loss.
It is made up of three key components:
- Revenue – how much money you brought in
- Expenses – how much you spent
- Net Income – how much money is left after subtracting expenses from revenue
There are a few other pieces to the puzzle which we’ll discuss later in “How to Prepare An Income Statement”, but those are the main categories you need to focus on.
Side note: A common misconception is that income statements and balance sheets are the same. They are not.
- Your company’s balance sheet provides a detailed look into what your business owns (assets) and what it owes (liabilities) as well as information about any investments you may have. (We did a deeper dive into balance sheets in another post titled: “How to Read a Monthly Balance Sheet.”)
- Your income statement simply shows whether or not your company is profitable.
Importance of Income Statements
Accurate income statements are vital to the success of your small business. They are one of your 3 most important financial statements. Used wisely, they all work together to help you make better business decisions and develop a solid financial strategy.
If your goal is to grow a profitable business that stands the test of time, you need to pay close attention to your income statements.
How to Prepare a Traditional Income Statement
Preparing a traditional income statement isn’t complicated. That’s good news for busy business owners who have plenty of tasks on their “to-do” list crying out for attention!
Here are 8 steps to preparing a traditional income statement:
- Choose a reporting period. We recommend that small business owners create income statements monthly, quarterly, and annually. Monthly statements allow you to make relatively quick adjustments when you see areas that need improvement. Quarterly and annual statements give you a much bigger “30,000-foot” view that helps you spot trends.
- Add up your total revenue. Income statements can be created for either your entire business or individual departments within your company. Be sure to include all revenue sources for whichever level of report you want to generate.
- Add up the Cost of Goods Sold (COGS). COGS are expenses related to producing and delivering whatever products or services you provide (labor, raw material, shipping, etc.)
- Calculate your Gross Profit. This is done by subtracting COGS from your total revenue.
- Calculate your Operating Expenses. Add up ongoing expenses unrelated to production such as rent, utilities, salaries, etc. These are simply your costs of doing business or “operating expenses” (OPEX).
- Calculate your income. Subtract OPEX from Gross Profit. The result is your actual income after all expenses. It is also referred to as “Earnings Before Interest and Taxes” (EBIT).
- Calculate Interest and Taxes. If you have any outstanding debts during the reporting period you are looking at, you will need to factor in any interest payments on them. Also, once you know your EBIT amount, you can then calculate taxes that you will owe.
Your CPA can help you navigate this step if those rates are hard to find or it’s just overwhelming. - Discover your Net Income. This is the step you’ve been waiting for! After subtracting all expenses from revenue (including interest and taxes) what you are left with is Net Income…or profit that is available to be used to grow your company.
Here’s a real-world example of a year-end Income Statement from Amazon from 2015-1017 provided by the Corporate Finance Institute.
If a company that big can produce a traditional income statement that simple…so can you.
Income Statement Best Practices
- Tips for accurate and effective preparation
- Regular updates and consistency
- Integration with Small Business Financial Statements for a comprehensive approach
The absolute #1 best practice for preparing an income statement (or any of your small business financial statements) is to start with accurate numbers. Like any recipe, your final product is only as good as your ingredients. So make sure you and your accounting team are using good information.
Other helpful tips include some things that people don’t often think about related to how you present your reports. Income Statements that are accurate but hard to read aren’t very helpful.
Your accounting software may automatically take care of some of these things, but if you are using your own spreadsheets, keep in mind these ideas including a few on presentation from Accounting Ware:
- Use a spreadsheet “line and column” format
- Use consistent colors, fonts, and numerical formatting.
- Bold all totals
- Show only the results, not the calculations
- Show Net Income at the bottom of the statement
Service Business Accounting
If you run a service-based business, your income statements will be even easier to create. Because you do not produce a product, you don’t have any Costs of Goods Sold. Therefore, your income statement is a simple matter of revenue minus expenses.
(Here’s a good sample service business income statement from accountinginfocus.com.)
Call Us For Help With Your Income Statements
Income statements are a powerful tool in your small business toolbox. Used often, they can provide you with valuable insights leading to better financial management. They are simple documents to create but can often seem complicated…especially if your numbers are already a mess. If you need help preparing or improving your income statements, schedule a call with one of our extremely experienced (40+ years!) small business accounting pros today.
