What is an Income Statement?

As your business grows, you’ll need to complete and submit certain documents to the IRS, state governing bodies, and your investors for annual reports and securing additional funding from the bank. One of these important documents is your income statement. Outside of required reporting, the income statement is one of the best tools  to enable a company to understand its current business operations and uncover insights for more strategic decision-making. 

Once you know how to read and assemble an income statement, you’ll be more equipped to understand the financial nuances of running your business.

What is an income statement?

The income statement reports on how profitable your business is during a set period of time. It is sometimes referred to as a profit and loss statement (P&L), a net income statement, or a statement of earnings. Business owners can see exactly how much they made during that period by reviewing the income statement. Along with reporting the current numbers, an income statement might compare one period to another, illustrating changes between those periods.

There are two key categories on your income statement: revenue and expenses (or losses). The income statement shows your total profit (income) as a result of subtracting your expenses from your revenue. 

The income statement might also have a breakdown of what makes up your revenue or expenses, like sales from different services, rent, and marketing costs. 

What is an income statement used for?

An income statement reveals whether or not a company is profitable. While sales numbers may be impressive and customers may be happy, the statement of earnings reviews how much the business actually made once the expenses are subtracted. Based on this report, a business owner can make strategic adjustments to become more profitable. 

Investors and lenders also want to look at your income statements to understand if your business is profitable and whether they should continue to support it. 

Income statement analysis.

The income statement presents your business’s revenues and expenses, gains and losses, and net income over a period of time. However, this data must be analyzed in the correct way in order to accurately find opportunities to improve your company’s profitability.

Financial metrics are one of the most common tools for income statement analysis. Using them involves calculating the ratio between line items and benchmarking your results against other businesses in your industry or your previous results.

For example, the gross profit margin tells you what percentage of your sales you keep after the direct costs to offer your product or services. The formula is as follows: gross profit margin = (net sales – cost of sales) ÷ (net sales). If yours is 40% while your competitors average 60%, you likely need to raise your prices or find ways to cut your cost of sales.

Variance analysis is another powerful method of income statement analysis. It typically involves comparing your actual profit and loss numbers to your expected or prior year numbers and investigating any significant differences between them.

For example, a general contractor might compare his direct labor expenses to a budget each quarter and investigate variances above 10%. If he finds he’s 17% over for a quarter, he might suspect that one of his subcontractors works too slowly and consider replacing them.

Income statement example.

Building an income statement for your business is easier if you’re familiar with their typical appearance and structure. Here’s an example of a straightforward income statement to give you a better idea of how they look.

How frequently do you look at your income statement?

Depending on your business, you will look at your income statement annually, quarterly, or monthly. For example, you may pull your income statement monthly to ensure your business is profitable and to prove that your company is growing over time. You can also use an annual income statement when you file reports with your investors or governing bodies in your area. 

Who assembles the income statement?

The role of reporting falls to different people depending on the size of your business. If you only have a small staff or operate as a sole proprietor, the burden of assembling an income statement could fall on you. However, once your business grows to a point where you can take on a bookkeeper or accountant, this person can step in and develop your financial reports beyond just an income statement. 

You may also decide to outsource financial services, like completing an income statement. To do so, you could work with an accounting firm to organize your books and put together these reports or find a freelance accountant to assist. 

Regardless of who completes your income statement, it’s important for you to familiarize yourself with income statements and other financial reports to help you gain more data and insight into your business.