Understanding income statements and how to create one

What is an income statement?

The income statement, also known as the profit and loss (P/L) statement, is a financial report that shows a company’s net profit or loss based on revenues and expenses over a given period. It is one of the five most important financial reports, along with the cash flow statement, the statement of changes in equity, the balance sheet and the notes to the financial statements.

Businesses normally prepare income statements for specific accounting periods — monthly, quarterly or annually. This report is essentially based on a simple formula for calculating profit or loss: subtract the total expenses from the total revenue during the period in question. What remains is either a profit or a loss.

Formula: Net profit/loss = total revenue - total expenses

This financial snapshot not only shows you where your business stands today, but also helps you make decisions for the future — whether you need to expand operations or cut costs to stay afloat.

Why is an income statement so important?

An income statement is more than just a financial report. Here are five ways it supports decision-making and strategic planning:

Assess financial health

This report provides insight into whether your business is thriving or struggling in a given period. Are profits on an upward trend or do losses indicate deeper financial problems? With these insights, you can take timely action.

Measure the company's performance

Use the income statement to assess whether your business is achieving its goals. Compare your performance with past periods and even with that of your competitors to identify strengths and weaknesses.

Guide strategic decisions

The income statement plays a central role in decision-making. If your profits are increasing, it may be time to expand or invest in new markets. If losses are piling up, you can shift gears — perhaps by discontinuing unprofitable products or streamlining operations to cut unnecessary expenses.

Make budget planning easier

Your income statement provides a roadmap for future budget planning. Analyzing current revenue and expenses allows you to forecast financial performance, which helps you create a more accurate and achievable budget.

Provide transparency for investors

Investors and creditors rely on income statements to assess a business’s potential. These reports show them whether your company can generate attractive returns or meet its financial obligations. In essence, a well-prepared profit and loss statement gives investors the certainty that your business is worth their trust — and their money.

Key elements of an income statement

Although formats may vary, income statements generally contain these four components:

Revenue

This is the total revenue generated from operations in a given period, including product sales, interest income and dividends.

Expenses

Expenses are the costs incurred by the company, such as production costs, administrative expenses and interest payments.

Profit

Profit reflects the financial gains made when revenues exceed expenses in a given period. It indicates the value added to the company’s equity.

Loss

A loss occurs when the company’s expenses exceed its revenues, resulting in a reduction in equity.

Types of profit or loss in an Income Statement

The profit and loss statement goes beyond just net profit or loss. It provides insights into other important financial figures such as:

1. Gross profit/loss

This key figure provides information on how much revenue remains after covering the cost of goods sold (COGS). It measures whether your sales can adequately cover production costs.

Formula: Gross profit/loss = Revenue - COGS

2. Operating profit/loss

The operating profit shows how much profit remains after deducting operating expenses from the gross profit. It provides information on how efficiently the business is operating.

Formula: Operating profit/loss = gross profit - operating costs

3. EBITDA

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) provides a deeper insight into performance as it excludes non-operating costs. It is an important indicator for comparing the profitability of different industries and measuring the company’s valuation.

Formula: EBITDA = operating income + interest + taxes + depreciation + amortization

Types of income statements

Depending on the level of detail required, companies use either a single-step or a multi-step format for the income statement:

Single-step income statement

The single-step income statement is simple and straightforward. It lists all revenues at the top, followed by all expenses. Net profit or loss is calculated by subtracting total expenses from total revenues.

Formula: Net profit = (income + profits) - (expenses + losses)

Due to its simplicity, this income statement format works well for smaller businesses. However, you may lack the detail that external stakeholders need for a deeper analysis. 

Below is an example of a single-step income statement.

Multi-step income statement

The multi-step format provides a more detailed breakdown, categorizing revenues and expenses to provide a comprehensive overview of your financial performance. In addition, the multi-step format is based on the following procedures for calculating net profit/loss.

Gross profit = Sales revenue - COGS

Operating profit = gross profit - operating expenses

Net profit = (operating profit + non-operating profit) - taxes

This detailed approach makes it easier for stakeholders, including investors, to analyze financial performance and make informed decisions before deciding to invest or inject capital into a company. Below is an example of a multi-step income statement

How to prepare an income statement

Creating an accurate income statement requires a lot of attention to detail. Here’s a step-by-step guide:

1. Define the reporting period and format: Decide whether the statement should cover a month, a quarter or a year and select the appropriate format - single or multi-step.
2. Collect financial data: Gather relevant data from transaction journals and the company’s general ledger to ensure all financial activity is captured.
3. Classify transactions: Organize transactions into categories such as revenue and expenses. You can further divide these into sub-categories such as operating and non-operating revenues or costs.
4. Calculate total revenue and expenses: Totalize all revenue and expenses based on the selected format.
5. Determine the net profit or loss: For the one-step format, subtract the total expenses from the total revenue. Meanwhile, for the multi-step format, calculate the gross profit, the operating profit and then the net profit after tax.

Make financial reporting easier with Aspire

Preparing income statements and other financial reports requires precision, but manual processes are prone to human error. Aspire offers a smarter way for you to create financial reports, especially in recording and tracking expenses, with its Expense Management solution.

With Aspire you can:

• Create budgets and track expenses in real time to ensure alignment with your financial goals.
• Empower your employees with Aspire Corporate Cards while staying in control of your expenses.
• Streamline claim and reimbursement processes for hassle-free financial management.
• All your financial data integrates seamlessly with your accounting software, so you can effortlessly produce accurate income statements and other financial reports.

Are you ready to take your financial management to the next level? Get in touch with our team today and discover how Aspire can help your business succeed!