How to Create and Read an Income Statement¹

How to Create and Read an Income Statement

An Income Statement is a vital report for any business, large or small. This report is essentially the scoreboard for your business. It tells you if you won (made a profit) or lost (didn’t make a profit) and by how much. This report can be used to compare how your business did in one period to a prior period to see if your business is improving.

The Income Statement is a report for a specific period of time (for example, a month, quarter or year) and it tells you three main things about a business for that time period:

  1. How much the business made in sales;
  2. How much the business spent in expenses;
  3. How much the business profited.

This report works closely with the Balance Sheet, another vital report for your business. The Balance Sheet states the health of the company from a financial standpoint at a given moment in time. The Income Statement states the overall performance of the company from an operational standpoint. Some transactions in your business could affect the Income Statement and Balance Sheet at the same time. The Income Statement is also sometimes referred to as a Profit & Loss Statement, or simply a P&L.

How to Create an Income Statement

As mentioned earlier, the Income Statement tells us three main things, how much the business made in sales, how much the business spent in expenses and how much the business profited (or lost). These three areas make up the three sections of the Income Statement. How much the business made makes up the Revenue section, how much the business spent makes up the Expenses section, and the profit (or loss) is simply the Revenue total less the Expense total.

Here is what a basic example of an Income Statement would look like for the entire year of 2017.

REVENUE

Sales (Department A)

$5,000

Sales (Department B)

$7,000

Cost of Goods Sold

($3,000)

Total Revenue

$9,000

EXPENSES

Payroll

$3,000

Utilities

$1,000

Supplies

$2,000

Rent

$1,000

Total Expenses

$7,000

Profit (Loss)

$2,000

How to Read an Income Statement

Using our example above, this company’s total revenue was $9,000. If we subtract out total expenses of $7,000 we get the net income (or profit) of $2,000. This example is a very basic Income Statement; however, most Income Statements for a business will follow this same format.

  • Revenue Section: This section is used to record all revenue that was earned during the time period of the Income Statement. You could group each major revenue item by department, division, product category, or whatever makes sense for your business. 

    You may have noticed that the Cost of Goods Sold section is in the revenue section and is a negative amount. The Cost of Goods sold is the total costs of a product or service that was sold during the specific time period of the Income Statement. The Cost of Goods Sold (or COGS) is generally located in the Revenue section of the Income Statement because it is tied directly with sales. It is generally a best practice to associate expenses that tie directly to sales and place them in the Revenue section of the Income Statement. In other words, if the sale never took place then the expense wouldn’t have either.
  • Expense Section: This section is used to record all expenses that were incurred during the time period of the Income Statement. Each expense is usually grouped by a major category, or expense account. Popular expense accounts would be payroll, utilities, supplies, rent, advertising, interest expense, or equipment.

One of the major benefits of the Income Statement is that you can compare the statement for one period to a prior period to see if you improved. For example, let’s compare the Income Statement above for the year 2017 to our Income Statement for the year 2016.

2017

2016

REVENUE

Sales (Department A)

$4,000

$5,000

Sales (Department B)

$9,000

$7,000

Cost of Goods Sold

($3,000)

($3,000)

Total Revenue

$10,000

$9,000

EXPENSES

Payroll

$4,000

$3,000

Utilities

$1,000

$1,000

Supplies

$5,000

$2,000

Rent

$1,000

$1,000

Total Expenses

$11,000

$7,000

Profit (Loss)

($1,000)

$2,000

As you can see, by comparing to a prior period you can gain insight into the operations of the business. Even though total revenue declined by $1,000 the company was able to make up for the difference by decreasing their total expenses. They were able to improve their bottom line, Profit (Loss), by $3,000.

The Income Statement is a very useful tool in gauging how well your business is doing by understanding how much you made in sales, how much you spent, and by how much you profited. By also comparing the Income Statement to prior periods you can gain some insight into areas where you can improve.