An income statement provides an at-a-glance summary that shows whether your business is earning a profit or losing money. Download this free sample template for an example of how to create an income statement of your own.
What Is an Income Statement?
An income statement is commonly referred to as a profit and loss statement, or P&L for short. You might think of it like your business’ financial report card. It’s an important financial statement that shows how much money your business has made or lost over a specific period of time.
In general, income statements are generated to track your company’s financial performance over one of the following time frames:
Once a time frame is selected, an income statement can measure the amount of money that came into your company during that period versus the amount of money that flowed out of it. This difference between business revenues and expenses is known as your profit or loss.
What Is an Income Statement Used For?
Income statements can be used for a few different purposes. Below are three of the most common reasons you might need to generate this report for your company.
First and foremost, an income statement helps you track the financial health of your company. If you generate a new income statement each quarter or each month (or maybe even for both periods), you’ll know quickly if your business’ income or expenses are getting off track.
When you apply for new business financing, your lender may require a copy of a recent income statement as part of your loan application. Along with your business credit and other factors, lenders can use your income statement to help judge the risk of loaning money to your company.
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Are you looking for outside investors for your business? Just like lenders may rely on income statements to help them determine how a business is performing financially, investors are interested in this information, too. By reviewing recent income statements from your company, an investor can better determine whether putting money into your business is a sound investment or a risky one.
If your business is publicly traded, an income statement is one of the key financial statements you’re required to prepare and report, per the Securities and Exchange Commission (SEC). Yet if your company is privately owned, you’re not generally required to create income statements.
What Items Appear on the Income Statement?
When you download an income statement template or create one on your own, it should be broken down into two major categories of information — income and expenses.
List of Income Sources
At the top of your income statement, you’ll enter a list of all the money your business earned during the accounting period. This should cover any deposits made into your business checking account.
However, you won’t list business deposits one by one on your income statement. Rather, you should group your business’ revenue sources into subcategories such as the following.
- Sales Revenue. This may include any money the business earned from the sale of goods or services.
- Affiliate Commissions. If your business earns affiliate commissions from selling or promoting another company’s products, any money earned from doing so would be included here.
- Royalties. Royalties are generally earned when your business creates a product or service that is sold by someone else.
- Rent and Lease Payments Received. Does your business receive revenue from leasing property or equipment to others? If so, the money earned during the reporting period can be included on your statement.
- Interest Revenue. This may include interest your business earns from investments or accounts with financial institutions.
- Gains. When your business sells an asset, like equipment or a piece of property, the money it gains from the sale can be added to your income statement.
List of Expenses
Underneath the revenue section of your income statement, you’ll want to record your business expenses. Expenses should include any time money left your business checking account. This section is typically longer and more detailed than your list of income.
Again, you don’t want to write out individual expenses on your P&L statement. You should group them into subcategories instead.
- Cost of Goods Sold. This may include expenses related to labor, raw materials purchased, storage, shipping, depreciation of equipment, and more.
- Operating Expenses (Administrative Expenses). Expenses that aren’t directly related to the manufacturing or sale of goods and services often fall into this subcategory. These expenses may include rent, utilities, marketing, salaries and wages, commissions paid, sales bonuses, insurance, accounting fees, office supplies, legal fees, and more.
- Employee Expense Accounts. If your employees use a company credit card or expense account to cover costs like travel, meals, or events, include those costs here.
- Interest Paid. Although you don’t include full loan payments on your company’s profit and loss statement, you should include any interest expenses you pay for financing. (Payments applied to the principal loan amount are included on your balance sheet.)
- Taxes. Include any income tax your business paid during the accounting period here.
- Miscellaneous Expense. If an expense doesn’t fit into one of the subcategories above, you can add it here.
Net Income or Net Loss
Once you’ve added income and expenses to your report, it’s time to calculate your company’s net income or net loss for the reporting period. This is commonly referred to as your bottom line.
To calculate net income (or net loss), simply subtract your total expenses from your total income. If you’re a visual person, the formula looks like this:
Total Revenue Earned – Total Expenses = Net Profit or Loss
If you come up with a positive figure, your business made a profit. This means that your business earned more money than it spent during the accounting period. If you end with a negative figure, your business experienced a loss. This means that your business spent more money than it earned.
You can also use an income statement to calculate your gross profit (aka gross margin) for the reporting period. Gross profit lets you see the amount of money your business would have made from sales without expenses like salaries (not tied directly to labor or sales), income tax, the cost of interest, or other administrative costs.
Typically, gross profit will be included as a separate line on your income statement. You can use the following formula to calculate gross profit.
Revenue – Cost of Goods Sold = Gross Profit
How Lenders Assess Income Statements
One of the primary reasons you need an income statement is to help your business qualify for funding. An income statement let lenders better assess the risk of doing business with your company when you apply for a loan.
But a single income statement might not be enough. Lenders and financial institutions may ask for several years’ worth of income statements when you fill out a new loan application. Why? Multiple income statements can provide a clearer picture of the financial growth or decline of your business over time.
To remain profitable, lenders need to avoid loaning money to companies that can’t repay the money they borrow as agreed. (Close to one-third of global small businesses report that financial troubles make it difficult to pay back lenders and vendors.) An income statement can help a lender predict your business’ financial capacity or, in other words, whether your business can afford the payments on a new loan.
Not sure how to create an income statement of your own? Here’s an example of an income statement that shows how the report should be put together.
Other Information That Matters to Lenders
Lenders may also consider information that isn’t found on your income statement. For example, having too much debt or no established credit might make it difficult (or expensive) to obtain business financing.
Any of the following might be considered when you apply for a new business loan:
- Other Financial Documents (Cash Flow Statement, Balance Sheet, etc.)
- Debt-to-Income Ratio
- Company Cash Flow
- Your Credit Reports and Scores (Personal and Business)
- Assets that Could Serve as Collateral
- Time in Business
- Annual Revenue
Income Statement vs. Balance Sheet
Be careful not to confuse your company’s income statement with its balance sheet. While both financial statements can help you track the financial wellbeing of your business, they serve slightly different purposes.
We’ve detailed above how an income statement works. It tracks your business’ revenues and expenses over a specific accounting period (e.g. a month, a quarter, or a year).
A balance sheet, on the other hand, is a snapshot of your business’ assets, liabilities, and equity at one specific point in time. Put simply, a balance sheet can help you calculate your company’s net worth.
Balance sheets also include information that typically isn’t included on a profit and loss statement, such as:
- Cash Reserves
- Accounts Receivable
- Petty Cash
- Intangible Assets
- Prepaid Expenses
- Owner’s Equity / Shareholders’ Equity
Calculate Your Net Income with the Balance Sheet Formula
The easiest way to figure your company’s net income is to use an income statement as detailed above. However, it’s sometimes possible to calculate net income using the information found on your business’ balance sheet as well.
As a reminder, net income is how much money a company made during a certain period like a month, a quarter, or a year. (If the company lost money during the reporting period, it would be called a net loss instead.)
To calculate net income using a balance sheet:
- Start with two balance sheets. For example, you could use the balance sheet from this year and one from last year.
- Compare equity. Take this year’s total equity figure and subtract it from last year’s total equity. If you made $100,000 in equity this year versus $50,000 last year, you experienced an increase of $50,000.
- Subtract new investments. Did you gain money from a new investor? Did you invest more money into your business yourself? If so, subtract those amounts from any increase in equity.
- Add dividends and equity payments back. Your business may have paid shareholders’ equity over the course of the year. Perhaps you were able to withdraw equity from your business as well. Either way, any dividends or equity payments made throughout the year should be added back.
- Calculate net income. Once you’ve compared the difference in equity between the two years, subtracted new investments, and added back in any dividends or equity payments, you’ll arrive at your company’s net income for the year.
Below is an example of how the balance sheet formula can be used to calculate net income.
The net income in the example above is $35,000.
- Year-Over-Year Equity Difference: +$50,000
- Minus New Investments Made in 2019: –$25,000
- Plus 2019 Dividends Paid: +$10,000
- Net Income = $35,000
You can use the following formula to try the process on your own.
Balance Sheet Formula for Calculating Net Income
Equity Difference – New Investments + Dividends Paid = Net Income
Does Your Business Really Need an Income Statement?
As a privately-owned small business, there’s a chance you might get by without creating income statements for your company — at least from a legal standpoint. Yet even if you discover you’re not legally required to create quarterly or yearly income statements, that doesn’t mean that skipping them is a good idea.
Income statements are important financial documents you may need to attract investors or qualify for commercial financing. Do you hope to sell your business in the future? Potential buyers may want to review your income statements as well.
Even if you don’t want to borrow and you’re not looking for outside investors or buyers, income statements still matter. By creating regular income statements (or paying someone to create them for you), you can discover whether your company is growing, declining, or remaining financially stagnant.
Income statements provide you with knowledge. That’s one of the most powerful tools you can use to help your business grow and succeed.