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.

Format of income statement

A format of an income statement is very important as it is the means of communication 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

How to calculate Income statement?

Businesses follow the below steps to calculate an income statement:

1. Choose the Reporting Period

Select a timeframe—monthly, quarterly, or annually—based on your business goals. Monthly reports offer quick insights for tactical shifts, while quarterly or annual reports help spot long-term trends.

2. Calculate Total Revenue

Add all revenue generated during the chosen period. Include all business lines or just specific segments, depending on the report’s focus.

3. Calculate the Cost of Goods Sold (COGS)

Determine direct costs tied to revenue-generating products or services, such as labour, materials, and distribution costs.

4. Calculate Gross Profit

Use the following formula to calculate the gross profit:
Gross Profit=Revenue−COGS
This gives a snapshot of profitability before accounting for operating costs.

5. Calculate Operating Expenses

Identify indirect costs like rent, utilities, office supplies, and legal fees. These are necessary for running the business but not tied to production.

6. Calculate Operating Income

Businesses then estimate their operating income using the following formula:
Operating Income=Gross Profit−Operating Expenses
Deduct interest payments and taxes from operating income.

7. Calculate Interest and Taxes

Deduct interest on debts and all applicable taxes for the reporting period.

8. Calculate Net Income

Use the formula below to calculate the net income:
Net Income=Operating Income−(Interest+Taxes)
This amount represents the company’s profitability for the reporting period.

Income statement example

Below is the income statement example of Max Associates, who are into legal consultancy service.

Types of income statements

Income statements come in various formats, each serving specific business needs. Understanding the different types helps businesses present financial information more clearly and aligns with their reporting objectives. The two major types of income statements include the following:

1. Single-step income statement

A single-step income statement follows a simple format with revenues and expenses categorised separately and subtracted to determine net income.
The key features include:

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

This is what a single-step income statement looks like:

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

This is what a multi-step income statement looks like:

How to prepare an income statement in Tally?

Income statement 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.

Income statement examples

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 consulting firm earns revenue primarily through client fees for professional services. Its main operational costs include employee salaries, office expenses, and project-related expenditures.

 Common mistakes to avoid while preparing income statements

Preparing an income statement requires careful attention to detail, as common mistakes can lead to inaccurate financial reporting. Errors such as misclassifying expenses, overlooking non-operating income, or failing to account for depreciation can distort a company’s financial health. 

• Incorrect revenue recognition: It signifies inaccurate recording of revenues. It normally occurs when revenue is recorded before it is earned and leads to misleading financial results and inaccurate income statements.
• Misclassification of expenses: It occurs when costs are wrongly categorised, potentially distorting profitability and affecting the accuracy of the income statement.
• Ignoring depreciation:  It leads to overstated profits by not accounting for asset wear and tear, resulting in inaccurate income statements.
• Overlooking tax deductions: This can result in higher reported profits, leading to inaccurate income statements and potential tax compliance issues.
• Not reviewing data – It can lead to overlooked errors, such as misreported figures or inconsistencies, resulting in inaccurate income statements.

Avoiding these mistakes ensures a more accurate and reliable economic analysis.

Benefits of Income Statement

An income statement offers numerous benefits, providing a clear view of a company's financial performance over a set period. Understanding these advantages allows investors, managers, and analysts to better evaluate a company’s financial health and growth potential.

Some of the benefits of maintaining an income statement are as follows:

• Financial transparency: It outlines all revenues and expenses, offering a transparent view of a company’s financial performance and operational efficiency.
• Performance tracking: It allows businesses to track performance by comparing revenues, expenses, and profits across different periods and identify trends and growth patterns.

Strategic planning: It aids in strategic planning by providing historical financial data, helping businesses create accurate budgets, and forecasting future revenues and expenses.

How do businesses prepare income statement?

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

Usage accounting software has helped the business owners to frequently check the income statement and accordingly take corrective actions when required. 

FAQs

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

An income 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.