An income statement, also called a profit and loss statement (or P&L), is a helpful tool you can use to track the financial performance of your business. It allows you to determine, at a glance, whether your business is making or losing money.
“An income statement shows your bottom line and whether your business is profitable over a period of time” explains Jo-Ann Yuen, a Chartered Accountant with 20+ years experience with multinational corporations and start-ups and the VP of Finance for Nav. “Profit is defined as revenue less expenses. It can be likened to household finances, where ideally the income or salary from work performed exceeds the expenses going out.”
As a business owner, you need to be familiar with your company’s income statement. It’s a document you should create and recreate frequently, ideally on a monthly or quarterly basis.
Not only do income statements allow you to keep a finger on the financial pulse of your company, they may also be important when your business applies for financing. Lenders frequently ask for income statements (along with other financial statements) whenever you fill out a loan application. Depending upon the lender’s requirements, the statement will likely need to cover a specific period of time — like a month, a quarter, or a year.
Although the thought of preparing financial statements can be intimidating to many small business owners, it’s actually not that difficult to prepare an income statement for your business once you know what you’re doing. In fact, you can usually start with an income statement template or a simple spreadsheet to get the job done.
Keep reading to discover six steps you need to follow to create an income statement of your own.
1. Open Up a Spreadsheet
The first step to create an income statement is easy. You need to open a basic spreadsheet on your computer. Excel and Google Sheets are the most popular options in this space.
Want a sneak peak in advance at what you’ll be creating? You can find an income statement example here.
2. Choose a Time Frame
Before you can prepare an income statement, you’ll first need to choose a specific period of time that the statement will cover. Most statements are based on one of the following three time frames:
If you choose to create a monthly income statement, it will help you calculate your business’ earnings or losses during that particular month. Quarterly and annual income statements look for the same information (profit or loss), but over a different time frame.
3. Create Two Sections: Income and Expenses
An income statement answers the following question: What is your business’ net income? The basic formula used to calculate net income is as follows:
|Income – Expenses = Net Income|
Before your can figure out your company’s net income, you need to separate your business’ finances into two sections on your spreadsheet. These sections are income and expenses (aka profit and loss).
On your spreadsheet itself, create two different columns to record business income and expenses. Once you’ve reviewed your bank statement(s) and separated the credits from the debits, you’ll need a place to enter this information.
Note: If you use accounting software like QuickBooks or FreshBooks, breaking down these two groups of information may be much easier. You can typically use your cloud-based accounting software to create a trial balance report that totals up the debits and credits from each of your company’s individual accounts. You can then use these figures in the next two steps.
4. List Out Your Sources of Income
Next, you’ll need to list out of your business’ income sources on a line-by-line basis. This will include any revenue your company earned during the reporting period (e.g. one month, one quarter, one year, etc.).
Possible income sources might include:
- Sales Revenue
- Revenue from Services Provided
- Interest Income Earned
- Affiliate Commission Revenue
- Rent Received
Once you have a list of all of the individual deposits into your business bank account for a given period of time, you should separate them into groups or subcategories. For example, you can tally all of the revenue collected from sales onto a single line. Underneath that line, you could list the total income from another source (like affiliate commissions earned). Repeat the process until every category (and every penny) of money earned has been included on your spreadsheet.
*Note: If you want to calculate your company’s operating income by itself, only include money generated from the business’ primary operations and exclude all other sources of income. This, however, won’t give you a true view of your overall net income, just the portion earned (or lost) from your primary business operations.
5. List Out Your Expenses
Now that you’ve listed out all of your company’s income sources, it’s time to switch your focus. The next items you’ll need to add to your spreadsheet are company expenses. You should comb through your bank statement(s) or general ledger and record every instance that money left your business bank account for any reason.
Possible expenses might include:
- Cost of Goods Sold (Labor, Materials, Equipment Depreciation, etc.)
- Operating Expenses (Salaries and Wages, Utilities, Rent, Advertising, etc.)
- Spending from Employee Expense Accounts (Travel, Meals, etc.)
- Tax Costs (Income Tax Expense, etc.)
- Legal Fees
- Interest Paid for Financing
Like income sources, you can combine expenses into broader groups or categories instead of listing them line by line. You can add up the cost of all wages/salaries paid and enter the combined amount as a single entry on your spreadsheet. Next, you might add individual lines for the total cost of rent paid, utilities paid, etc. Or, you might opt to combine all of those expenses and list the business’ total “operating expenses” for the period of time in question.
However you list your company’s expenses on your spreadsheet, be sure that every penny spent has been included and is deducted from income earned. In order for your business’ income statement to be accurate, the data you put into your spreadsheet must be 100% correct.
6. Calculate Your Net Income at the Bottom
The final step in creating an income statement is calculating your net income (also called net profit or net earnings) at the bottom of the spreadsheet. If you’ve ever heard someone refer to a company’s “bottom line,” the term refers to this final entry on an income statement.
First, you’ll need to add up all of the income listed on your spreadsheet. Next, you should subtract all of the expenses listed from the amount of money earned. Be sure to double check your math for good measure.
The final number you’re left with will be your company’s net income for the period of time you included in your spreadsheet. This number tells you how much money your business earned or lost during the accounting period selected.
The six steps above provide a guideline on how to create a basic income statement. Below you’ll find a few additional notes that are important to understand about income statements as well.
- Publicly traded companies are required to file financial statements with the Securities and Exchange Commission (SEC). These financial statements may include an income statement, cash flow statement, balance sheet, changes in shareholders’ equity, and comprehensive income.
- Income statements are a great way to track your business’ progress toward long-term goals. When you create multiple income statements, you can view your company’s financial growth or decline over time. For example, you can compare this quarter’s income statement with the statement from the same period of time last year to learn if your company is earning more or less money.
- Positive income statements may be useful when you try to attract investors or apply for new commercial financing like business loans or lines of credit. If you have several income statements in a row that show financial growth, it may demonstrate that your company is potentially a good investment or a lower credit risk for lending purposes.
Should You Hire a Pro?
It’s smart to cut costs where you can in your business. Yet for some business owners, the process of preparing an income statement can feel overwhelming or too time consuming — especially the first time.
You can always hire an accounting professional to help you if you don’t want to prepare an income statement. However, if you feel comfortable preparing statements and tracking your company’s financial metrics on your own, you could avoid adding another accounting expense to your budget.
The decision whether or not to hire a pro is personal. However, either way, someone should prepare income statements for your company on a regular basis.