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Understanding an Income Statement (Definition and Examples)

This article is Tax Professional approved Group

How profitable is your business? The only way to really know is to create an income statement.

Here’s how to put one together, how to read one, and why income statements are so important to running your business.



What is an income statement?

An income statement is a financial statement that shows you how profitable your business was over a given reporting period. It shows your revenue, minus your expenses and losses.

Also sometimes called a “net income statement” or a “statement of earnings,” the income statement is one of the three most important financial statements in financial accounting, along with the balance sheet and the cash flow statement (or statement of cash flows).

Small businesses typically start producing income statements when a bank or investor wants to review the financial performance of their business to see how profitable they are.

When a business owner makes an income statement for internal use only, they’ll sometimes refer to it as a “profit and loss statement” (or P&L).

Learn more:

Income statement example

Here’s an income statement we’ve created for a hypothetical small business—Coffee Roaster Enterprises Inc., a small hobbyist coffee roastery.

Coffee Roaster Enterprises Inc.

Income Statement

For Year Ended Dec. 31, 2021

Category Amount
Sales Revenue $57,050.68
Cost of Goods Sold (COGS) $24,984.79
Gross Profit $32,101.89
General Expenses $11,049.55
*Rent $9,000.00
*Bank & ATM Fee Expenses $9.43
*Equipment Expenses $742.40
*Marketing Expenses $503.53
*Merchant Fees Expenses $794.19
Operating Earnings $21,052.34
Interest Expense $5,000.00
Earnings Before Income Tax $16,052.34
Income Tax Expense $10,000.00
Net Profit $6,052.34

Income statements are designed to be read top to bottom, so let’s go through each line, starting from the top.

Further reading: How to Read (and Understand) an Income Statement

Sales revenue

Every income statement begins with your company’s revenues.

How you calculate this figure will depend on whether or not you do cash or accrual accounting and how your company recognizes revenue, especially if you’re just calculating revenue for a single month.

Generally speaking, this figure will simply represent your total revenue for whatever time period the income statement is covering. (In this case, the time period is the year ending on December 31, 2021.)

Cost of goods sold

Often shortened to “COGS,” this is how much it cost to produce all of the goods or services you sold to your customers. If the company is a service business, this line item can also be called Cost of Sales.

COGS only involves direct expenses like raw materials, labor and shipping costs. If you roast and sell coffee like Coffee Roaster Enterprises, this might include the cost of raw coffee beans, wages, and packaging.

Indirect expenses like utilities, bank fees, and rent are not included in COGS—we put those in a separate category.

Gross profit

This is what you get when you subtract total COGS from revenue. Gross profit tells you your business’s profitability after considering direct costs but before accounting for overhead costs. It’s a rough measure of how efficient your business is.

General expenses

Also sometimes referred to as “operating expenses,” these include rent, bank & ATM fee expenses, equipment expenses, marketing & advertising expenses, merchant fees, and any other expenses you need to make to keep your business going.

These expenses are listed individually here, but some income statements will bundle these and other similar expenses together into one broad category called “Selling, General & Administrative Expenses” (SG&A).

If an expense is unrelated to core business activities, it’s known as a “non-operating expense.”

Operating earnings

This is how profitable your business is after subtracting all internal costs, which you have more control over, but before accounting for external costs like loan interest payments and taxes, which you have less control over.

Accountants will sometimes call this Operating Profit or Operating Income.

Interest expense

If your business owes someone money, it probably has to make monthly interest payments. Your interest expenses are the total interest payments your business made to its creditors for the period covered by the income statement.

Earnings before income tax

This is your business’s profitability before it pays its taxes.

Income tax expense

This is how much you paid Uncle Sam.

Net profit

Ever wonder where we get the expression “bottom line” from? This is it! Net profit, also called “net sales” or “net earnings,” is the total profit for your business.

Income statement template

You don’t need fancy accounting software or an accounting degree to create an income statement. Our expert bookkeepers here at Bench have built an income statement template in Excel that you can use to assess the financial health of your business and turn your financial information into an income statement.

What is a single-step income statement?

The income statement we showed you above is technically called a “multi-step” income statement because you have to perform multiple calculations to arrive at your final net income. (In this case, we calculated gross profit, then subtracted general expenses, interest, and income tax expenses to find our net income.)

Multi-step income statements separate operational revenues and expenses from non-operating ones. They’re a little more complicated but can be useful to get a better picture of how core business activities are driving profits.

A single-step income statement, on the other hand, is a little more straightforward. It adds up your total revenue then subtracts your total expenses to get your net income. Simple.

Here’s an example single-step income statement we created for another hypothetical company, Dead Simple Coffee Inc.:

Dead Simple Coffee Inc.

Income Statement

For Year Ended Dec. 31, 2021

Category Amount
Revenues and Gains
Sales revenue $57,833.72
Capital gains $4,477.34
Total revenues and gains $62,311.06
Expenses and Losses
Cost of goods sold (COGS) $22,276.72
Rent $8,299.22
Bank & ATM Fees $21.83
Equipment expenses $987.82
Marketing and Advertising expenses $1,387.22
Interest expense $4,538.34
Income tax expense $13,900.22
Total expenses and losses $51,411.37
Net income $10,899.69

The single-step format is useful for getting a snapshot of your company’s profitability, and not much else, which is why it’s not as common as the multi-step income statement. But if you’re looking for a super simple financial report to calculate your company’s financial performance, single-step is the way to go.

What is a common size income statement?

Common size income statements include an additional column of data summarizing each line item as a percentage of your total revenue.

For example, here’s the income statement for Coffee Roaster Enterprises Inc. we mentioned earlier, done up as a common size income statement:

Coffee Roaster Enterprises Inc.

Income Statement

For Year Ended Dec. 31, 2021

Category Amount Percent
Sales Revenue $57,050.68 100.00%
Cost of Goods Sold (COGS) $24,984.79 43.79%
Gross Profit $32,101.99 56.27%
General Expenses $11,049.55 19.37%
*Rent $9,000.00 15.77%
*Bank & ATM Fee Expenses $9.43 0.01%
*Equipment Expenses $742.40 1.30%
*Marketing Expenses $503.53 0.88%
*Merchant Fees Expenses $794.19 1.39%
Operating Earnings $21,052.44 36.90%
Interest Expense $5,000.00 8.76%
Earnings Before Income Tax $16,052.44 28.14%
Income Tax Expense $10,000.00 17.53%
Net Profit $6,052.44 10.60%

Common size income statements make it easier to compare trends and changes in your business.

For example: if your Operating Earnings change from $21,052.44 to $23,443.33, that might not tell you much by itself, because other numbers might have changed as well. But if your Operating Earnings increase from 36.90% to 44.23%, that’s a concrete, significant change in your business.

What about depreciation?

Depreciation is the process of deducting the total cost of something expensive purchased for your business. However, instead of doing it all in one tax year, you write off parts of it over time. When you depreciate assets, you can plan how much money is written off each year, giving you more control over your finances.

Depreciation expenses are reported like any other normal business expense on your income statement, but where you include it depends on the nature of the asset being depreciated.

Depreciation is listed with Cost of Goods Sold if the expense associated with the asset is used in the direct production of inventory. For our coffee roaster examples, depreciation of production equipment and machinery (like the roaster itself) would be included with COGS.

Depreciation goes under general expenses, though, if the expense is associated with non-production fixed assets. The depreciation of office equipment for our coffee roasters, for example, would be listed as a general expense.

Note: Amortization is similar to depreciation, but instead of depreciating the value of a tangible asset, you depreciate the value of an intangible asset. Intangible assets are a little trickier to pin down, but think intellectual property or your existing client list. Check out this Bench blog on Form 4562: A Simple Guide to the IRS Depreciation Form for more on amortization.

Learn more: What Is Depreciation? and How Do You Calculate It?

Income statement vs. balance sheet: what’s the difference?

A balance sheet shows you how much you have (assets), how much you owe (liabilities), and how much is remains (equity). It’s a snapshot of your whole business as it stands at a specific point in time.

An income statement describes how profitable your business is. It shows you how much money flowed into and out of your business over a certain period of time.

Further reading: Income Statements vs. Balance Sheets

What's Bench?

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This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.

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