What is an income statement?

An income statement shows you whether your business is making money or losing it. This can help you identify areas for growth or where you may need to troubleshoot. So what should an income statement include and how do you create one?

An income statement shows you whether your business is making money or losing it. This can help you identify areas for growth or where you may need to troubleshoot. So what should an income statement include and how do you create one?

Emily Kindness
From the Business team
5
minute read
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Posted 30 SEPTEMBER 2021

What is an income statement? 

An income statement is a financial report that shows a business’s profit and loss over a given time. It’s typically compiled monthly, quarterly or annually.

It lists your income and expenses, with the final figure revealing if the business has made a profit or a loss. That’s why an income statement is also sometimes known as a profit and loss statement. 

It’s one of three key financial statements used by businesses, along with cash flow and balance sheet. 

There are two basic types of income statement you can use – single-step or multi-step.

What is a single-step income statement? 

A single-step statement offers a snapshot of a business’s profit using a single equation. This makes record keeping easier. 

All revenue and gains (your earnings) are totalled at the top of the statement, with all expenses and losses (your outgoings) subtracted at the bottom – hence the term ‘bottom line’ to represent revenue you’re left with.  

While they’re simple to understand, single-step statements may also be thin on information. If you’re looking to secure investment or a loan, you may need to produce more detailed accounts. But for many small businesses and self-employed people, the single-step method provides all the details they need to assess financial health.

What is a multi-step income statement? 

A multi-step income statement provides an in-depth look at a business’s financial health, using multiple sub-totals to calculate profit. 

This method separates operating revenue and expenses from non-operating revenue and expenses. In other words, income generated from your core business activities versus other income. This allows you to calculate things like gross profit and operating profit (the total earnings from your core business, excluding the deduction of interest and taxes). 

Although they’re more detailed, multiple-step income statements can be labour intensive to produce because of the wealth of data involved. 

Bigger companies usually opt for multi-step income statements because they have a complex list of activities and expenses to record.

What should I list on an income statement? 

Whether you use accounting software or a spreadsheet to lay out your figures, the main contents of an income statement tend to include: 

  • Revenue or sales – the total value of goods or services sold to customers.
  • Cost of goods sold – the direct costs involved in selling your products, for example raw materials and labour. It’s calculated by adding the opening stock (current value of stock) to purchases, then subtracting the closing stock (value of stock at the end of the reporting period).
  • Gross profit – the difference between your revenue and the cost of goods sold.
  • Expenses – all the indirect costs incurred by the business, like rent, utilities, salaries and business insurance.
  • Net profit – this is your total revenue once all your expenses have been deducted. If the number is positive, your business is reporting a profit. If it’s negative, you’re recording a loss for the reporting period. 

Here’s an income statement example in very basic form, just to give you an idea of some of the information you can expect to find:

  £ £
Revenue/sales   98,000
Less cost of sales    
Opening stock 9,000  
Add purchases 38,000  
Subtotal 47,000  
Less closing stock 10,000 37,000
Gross profit   61,000
Less expenses    
Rent 4,800  
Utilities 1,000  
Wages 16,000  
Marketing costs 500  
Stationary 900  
    23,200
Net profit   37,800

Why are income statements important? 

An income statement is a valuable document because it shows you the overall profitability of your business. This is crucial to ensuring you don’t spend beyond your means. It also helps you make important business decisions, like whether you’re in a position to take on new projects and investments. And you can compare profits over different time periods to see whether certain times of the year are more lucrative than others.  

All limited companies need to file a profit and loss sheet with HMRC for each financial year for tax purposes. If you’re self-employed, it can be helpful to have an income statement to make completing your self-assessment return easier.

Frequently asked questions

What are revenue and gains?

In financial accounting, revenue is money generated through a business’s day-to-day operations. A gain is any economic benefit that’s outside its normal operations. This might be from the sale of a building or an asset.

For example, when a supermarket receives cash for selling groceries, that’s revenue. But when it makes money by selling an old delivery van, it’s a gain because its core business isn’t selling vans.

What are expenses and losses?

An expense is the money spent, or costs incurred, by a business to enable the smooth running of its day-to-day operations, for example overheads like rent and utility bills. A loss, on the other hand, is when you lose money through a secondary activity, for example selling an asset for less than it’s worth.

How do I read an income statement?

An income statement format is designed for you to read from the top line (sales revenue), with the costs involved in generating that revenue just below. Profit and loss is displayed at the bottom of the report – the ‘bottom line’. Each step down the ladder involves the deduction of an expense to arrive at the final net income, which is the total amount you’ve made over a given period. 

Once you understand how all the different lines interact and what they mean for your business’s financial performance, you’ll be in a better position to see where you need to fine tune, boost productivity or cut back your day-to-day operations.

What are income statements used for?

There are many reasons why you would produce a profit and loss statement. The main purposes of an income statement include: 

  • seeing, at a glance, the profits and losses your business has made in a particular period
  • analysing losses to see where you can streamline and reduce expenses
  • complying with the law (all limited companies must produce an income statement)
  • tax reasons (you need to work out your profits so your tax payments can be calculated)
  • comparing profits and losses over previous years to identify seasonal trends
  • making comparisons with competitor businesses in the same industry to see how well you’re doing

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