Income Statement: Definition, Components, Format, & Examples

• What is Income Statement
• Components of Income Statement
• Income statement format
• Income statement example
• Why do businesses prepare income statement?
• How do businesses prepare income statement?

An income statement is one of the most significant financial statements that help illustrate a business organisation's financial performance during a particular period. It gives information on revenue, expenditures, and net profit, thereby enabling management and other stakeholders to make informed decisions. An income statement allows a businessperson, investor, or accountant to assess a firm’s financial health.

This guide will cover the basic understanding of an income statement, its components, categories, format when to use it, examples, and how to prepare a good one.

What is Income Statement

The income statement presents information on the financial results of a company’s business activities over a period of time.

It communicates to users how much revenue the company has generated during the period and the cost incurred by it in connection to generating such revenues. Income Statement is also called by different names as “statement of operations” or “statement of earnings” or “profit and loss statement”.

A business engaged in services usually prepares an income statement instead of profit & loss a/c. While the objective remains the same, owing to the difference in the nature of the business, few components are different in the income statement.

Components of income statement

Revenue

Revenues are the amounts from the sale of goods and services in the normal course of business. And net Revenue means all proceeds from the sale of goods and services excluding the returns.

 For example, Zen Phones, an electronic store selling phones and computers. This implies that Company A is in the sales business and its revenue is from the sale of computers and mobile phones.

Let’ take another example.

Max associates is a law firm rendering consultancy services to its clients. Here, they are engaged in the business of rendering services for which it charges a fee. So here fee is the revenue forming part of Income Statement.

However, there are also other forms of revenue such as interest income, royalty income, rental income etc. that will be part of the statement.

Expenses

Expenses are the amounts incurred to generate revenue and includes the cost of rendering services such as operating expenses, interest payments, rent, salaries and wages, taxes etc.

For example, Max associates is a law firm providing legal consultancy services to its clients.

In the process of rendering services, the company will incur various expenses such as promotional expense (advertisement expenses), sales managers’ salaries, depreciation on the usage of fixed assets and other administrative expenses to earn revenue by rendering services. All these expenses form part of the income statement as they are incurred in relation to such revenues.

Net income

Here, the net income is nothing but an excess of revenue over the expenses. In other words, after deducting all the expenses and taxes from the revenue earned during the period, remaining is the net income from the business operation.

Cost of goods sold (COGS)

The cost of goods sold (COGS) is any direct cost related to the production of goods that are sold or the cost of inventory you acquire to sell to consumers. It does not include overhead expenses related to the general operation of the business, such as rent. Cost of goods sold is reported on a company's income statement.

Read more: Cost of Goods Sold (COGS): Definition, Formula, Calculation and Example

Gross profit

Gross Profit is defined as net sales minus the cost of goods sold. Gross profit is sometimes referred to as gross margin.

Marketing, advertising, and promotion expenses

These are the expenses related to selling goods and/or services. Marketing, advertising, and promotion expenses are often grouped together as they are similar in nature and relate to selling.

EBITDA

EBITDA aka Earnings before Interest, Tax, Depreciation, and Amortization is calculated by subtracting SG&A expenses (excluding amortization and depreciation) from gross profit.

Depreciation expense

Depreciation, also known as amortization are non-cash expenses that are created by accountants to spread out the cost of capital assets such as property, plant, and equipment (PP&E).

Operating income (or EBIT)

Operating income is nothing but whatever your business has earned through its regular operations. In other words, it’s the profit before any non-operating income, non-operating expenses, interest, or taxes are subtracted from revenues. EBIT is a term commonly used in finance and stands for Earnings Before Interest and Taxes.

Interest

It is not uncommon for companies to call interest expense and interest income separately in the income statement so that reconciliation of the difference between EBIT and EBT is more accuarate.

Other expenses

These expenses are specific to the industry your company comes under. Since each industry expenses are unique in nature, whatever transactions do not cater to other categories, fall under "other expenses".

EBT (Pre-Tax Income)

EBT stands for Earnings Before Tax, also known as pre-tax income, and is found by subtracting interest expense from Operating Income. This is the final subtotal before arriving at net income.

Income taxes

Income taxes are the relevant taxes charged on pre-tax income. The total tax expense can consist of both current taxes and future taxes.

Net income

This is calculated by deducting income taxes from pre-tax income. This is the amount that flows into retained earnings on the balance sheet, after deductions for any dividends.

Types of income statements

1. Single-step income statement

A single-step income statement follows a simple format with revenues and expenses categorized separately and subtracted to determine net income. 

The key features include:

• It simplifies financial reporting.
• Considered best for small businesses with straightforward operations.

Example:

2. Multi-step income statement

A multi-step income statement provides detailed insights by breaking down revenues, expenses, and profit levels.

The key features include:

• It offers better financial analysis
• It helps in understanding operational efficiency

Example:

Format of income statement

The format of an income statement is very important as it is the means of communicating of operating results to outsiders. The income statement format includes details such as the company’s name, the title stating, “Income Statement”, the period covered, and other key components as discussed above.

Single-step income statement format

Income statement example

Here are industry-specific examples of income statements:

Retail business

A retail company’s income statement typically includes product sales, discounts, and inventory costs.

Service business (consulting firm)

A service firm has revenues from consulting fees and operational costs like salaries.

Why is an income statement important?

An income statement is an important financial statement that business organizations should prepare for the following reasons.

• Performance measurement – It can be used to determine the profitability of the company through evaluations.
• Decision-making - It is crucial in business, where business owners and investors use it to make specific financial decisions.
• Financial analysis – Analysts compare the returns and revenue models and performance, as well as the cost structure of the business.
• Budgeting & forecasting – enables companies to forecast the future of the company by predicting past trends.
• Auditing – It helps in tax filing and compliance with financial regulations.
  

Why do businesses prepare income statements?

We must mainly remember one thing a company does not operate wholly on owned funds, it borrows money from outsiders to run its operational activities.

So, the external users of the income statement i.e. investors, creditors, and other lenders must make decisions about resource allocation as to where to put their money. They use the income statement to find out answers to the questions they may have about the future profitability of the business.

• For investors – This statement will help them to decide whether to keep or sell the shares they own in the company. The investors also use the income statement to determine the ability of a company to pay dividends.
  
  
• For lenders - Lenders use the income statement to find out whether the company will be able to repay the loan with interest in the future.
  
  
• Creditors – They use the income statement to determine whether the company will be profitable enough to repay their debts as they come due.

How do businesses prepare income statements?

With the help of ERP software, preparing an income statement is made a lot easier. Gone are those days when you need to wait for the closure of books to determine the net income. Today, most businesses have automated the preparation of various financial statements including income statements using ERP software or accounting software.

The usage of accounting software has helped business owners to frequently check their income statements and accordingly take corrective actions when required. 

How to prepare an income statement in Tally?

The statement of income preparation has been made easier with the help of Tally, as the software is capable of preparing automated reports. Here is the step-by-step guide for preparing an income statement using Tally:

• Open tally and select company - To generate the required report, the user needs to select the company they work for.
• Choose profit & loss a/c – Locate the “Profit & Loss Account” under the company’s report list.
• Select the period – You may select the period for which you want to apply the changes or choose from the financial year or any specific date range.
• View and analyse the report – The program also produces an income statement in a pre-built format.
• Export and print – Save the report in PDF or Excel for further analysis.
  

FAQs

1. What is the main purpose of an income statement?

The statement summarises a company’s revenues, expenses, and net income over a period, helping assess profitability and financial performance.

2. How is the net income calculated on an income statement?

Net income is calculated as the difference between the total revenue and total expenses. A positive result means profit, whereas a negative result indicates loss.

3. What is the difference between a single-step and multi-step income statement?

A single-step statement calculates net income in one step (Revenue - Expenses). On the other hand, a multi-step statement separates operating and non-operating activities for a detailed analysis.

4. Can an income statement help in decision-making?

Yes, it provides critical data for budgeting, investment, and operational planning for users to make wise decisions.