Despite being the most fundamental calculation in finance, the income statement formula still trips small business owners up all the time. The whole point is to answer the real question you care about: did the business make money or lose it during a specific period?
The simplest way to think about it: Revenue – Expenses = Net Income.
However, the devil is in the details, as they say. Actually figuring out what counts as an expense, what’s really accounted for in revenue, and where you pull these figures from is the tricky part. So, we put together this guide on how to calculate an income statement to take the stress away.
You can use the GlassJar small business accounting software if you want to avoid the hassle altogether, for what it’s worth. It automatically generates income statemsents from your transaction data. Spend less time manually building reports and focus on interpreting them!
Key Takeaways
- The formula for income statement is simply Revenue – Expenses = Net Income
- Single-step income statements add everything in a single calculation; multi-step income statements break out gross profit and operating income.
- The income statement only shows profitability over a period of time. Not assets, cash on hand, or liabilities.
- Calculating income statement figures yourself shows you what drives your margins even if software handles the math for you.
Income Statement Overview
Whether you call it an income statement or a profit-and-loss statement (P&L), this report sums up the revenue you earned and expenses you incurred over a specific time frame. Could be a quarter, a year, or even a month if you want to get really granular.
You’re left with one of two things after running the income statement formula:
- Net loss
- Net profit
Hopefully, it’s the latter.
Either way, though, you need an income statement if your business files taxes, applies for loans, or reports to investors. The question comes down to how detailed you want the report to be.
Single-Step Income Statements
This basic report groups all your revenues and expenses and then subtracts one from the other.
Total Revenue – Total Expenses = Net Income
Simple. This is more than enough for small businesses with very straightforward operations. However, it won’t cut it if you need to be able to isolate gross profit or operating income. It’s too hard to see where margin is being gained or lost.
Multi-Step Income Statements
This method separates the income statement formula into multiple stages, as the name implies.
- Subtract the cost of goods sold (COGS) from revenue – that’s your gross profit.
- Subtract operating expenses to arrive at operating income.
- Account for interest, taxes, and non-operating items to get your net income.
This formula for income statement calculation is obviously a bit more involved, but the payoff is visibility. We’ll teach you how to calculate the income statement this way below.
Why an Income Statement is Important (and What it Won’t Tell You)
In the simplest sense, your income statement is a barometer for whether or not your business was profitable over a period. It tells you how much revenue came in, where expenses went, and how margins are trending from one period to the next.
You’ll have to prepare an income statement if you want any investors and/or lenders to work with your business. It’s also the starting point for tax prep, budgeting, and forecasting. Way down the road, if you ever decide to sell your business, you’ll have to prepare an income statement for potential acquirers.
However, you should know that an income statement isn’t the end-all, be-all of your company’s financial situation. There are actually quite a few important data points it DOESN’T take into account, such as:
- How much cash you actually have (that’s the cash flow statement)
- What assets and liabilities your business holds (that’s the balance sheet)
- Whether revenue has been collected or is stuck in accounts receivable
On that last point, it’s worth noting that income statements are calculated through accrual accounting methods. That means revenue is recorded when you earn it and expenses are jotted down when they’re incurred – not when money actually moves into/out of your bank account.
This is to say, you can have a profitable income statement and still have an empty bank account. So, income statements are to be taken with a grain of salt.
What Makes Up the Income Statement
There are three core components of every income statement regardless of how it is calculated.
Revenue
The “top line” is all your income from the company’s primary operations. That’s sales for a retailer. Service fees for a consulting firm. Whatever your core business activity is.
Revenue also accounts for secondary income, including interest earned, rental income, or royalties. It’s imperative that operating revenue is differentiated from non-operating revenue, though, because they paint a very different picture about your company’s financial health.
Revenue always sits at the top of the statement, and everything else gets subtracted from it.
Expenses
There are a few categories that fall under the main “expenses” umbrella.
You have your COGS, which are all the direct costs associated with making or delivering whatever you sell. Raw materials, manufacturing costs, etc. Operating expenses, which cover all the overhead. Rent, salaries, utilities, marketing, insurance. A third type of expense is your non-operating expenses. This is stuff like interest on debt, income taxes, etc.
These separate categories are disregarded on the single-step income statement formula. They’re broken out separately on the multi-step formula, though.
Profit/Loss
This is the number at the very bottom of the income statement – which is why this report is also called a profit & loss statement by many accountants.
Gross profit is your revenue minus COGS.
Operating income is gross profit minus operating expenses.
The real bottom line is net income – what’s left after everything has been subtracted.
It’s quite common for expenses to exceed revenue. You have what is referred to as a net loss in this case, rather than net profit. Breaking all of these different “costs” out through a multi-step approach helps you get better clarity into where margin is being made/lost.
Calculating the Income Statement Formula
Here’s a quick walk-through of the multi-step income statement formula.
Step 1. Choose a Reporting Period
The first thing you have to do is determine what period you’re looking at – monthly, quarterly, or annually. Each timeframe has its insights and limitations. For example, monthly reports are great for informing operational decisions whereas quarterly reports align with tax deadlines. Annual snapshots are the full picture that most people care about as far as external reporting goes.
Pick whatever period matches what you need the data for. Then proceed to step two.
Step 2. Find Your Trial Balance Report
This is a list of every account balance in the general ledger at the end of the reporting period. In other words, it’s the raw material you’ll use to calculate your income statement. It gets automatically generated by your accounting software.
Step 3. Add Up All Your Revenue
Pull in and total up every revenue account from the trial balance report. Primary revenue plus secondary income. This is your top line from which you’ll start subtracting.
Step 4. Factor in Cost of Goods Sold/Services Rendered
Total all the DIRECT costs associated with making your product or delivering your services. This one trips people up because they aren’t sure what constitutes a direct cost. For product-based businesses, it includes:
- Raw materials
- Manufacturing labor
- Shipping
It’s contractor payments, project-specific software, or materials consumed during delivery for service-based businesses. It’s easier for the line between COGS and operating expenses to get blurred for service-based businesses.
A good rule of thumb: if the cost disappears when you stop delivering the service, it’s COGS.
Step 5. Determine Gross Profit
Gross Profit = Total Revenue – COGS
This number tells you exactly how much you’re earning on your core offering before overhead eats away at it. You can’t save your business through operational cost-cutting if your gross profit is too thin. Either the pricing model or cost structure needs to change.
Step 6. Bring in Operating Expenses to Calculate Operating Income
Operating expenses can include quite a few things. Rent, employee salaries and benefits, utilities, marketing, office supplies, insurance, and depreciation are the most common examples. Your business may have some unique ones, though.
Some operating expenses are fixed; others are not. For example, your rent won’t change just because you had a good or bad month. On the other hand, marketing spend can scale up or down depending on how business is doing.
At any rate, subtract all your operating expenses from the gross profit – that’s your operating income. This tells you how profitable the core business is.
Step 7. Add in Interest and Income Tax Expenses
All that’s left to do now is tally up interest payments on outstanding debt along with estimated income tax from operating income. Some businesses have non-operating income (investment returns, one-time gains) as well – that gets added here, too.
Step 8. Calculate Net Income
Net Income = Operating Income – Interest – Taxes +/- Non-Operating Items.
This is your bottom line. Positive numbers are profits. Negative numbers mean your company took a loss in the period. This final number flows into retained earnings on the balance sheet, directly impacting the owner’s equity.
Income Statement Calculation Example
The income statement formula can make a little more sense when you look at it actually play out – this chart walks you through how to calculate an income statement using actual dollars and cents:
| Revenue | |
| Consulting Fees | $450,000 |
| Workshop Revenue | $12,000 |
| Total Revenue | $462,000 |
| Cost of Goods Sold | |
| Contractor Payments | $68,000 |
| Software Licenses | $17,000 |
| Total COGS | $85,000 |
| Gross Profit | $377,000 |
| Operating Expenses | |
| Salaries & Benefits | $108,000 |
| Rent | $36,000 |
| Marketing | $18,000 |
| Insurance | $12,000 |
| Office Supplies | $6,000 |
| Total Operating Expenses | $180,000 |
| Operating Income | $197,000 |
| Interest Expense | $4,200 |
| Income Tax (25%) | $48,200 |
| Net Income | $144,600 |
You can see the firm had about $377,000 in gross profit on an 81.6% gross margin. It retained $144,600 after all expenses, interest, and taxes. That’s a really solid 31.3% net profit margin.
Someone interpreting this might be looking for areas to improve margin. They’d see that salaries made up the biggest operating expense at 23.4%. They could get even more granular and break out each department as a separate line item, and then have honest conversations about what’s necessary and what’s fat that could be trimmed.
Speaking of which…
What Can You Do With Your Income Statement Now?
The value isn’t just in providing your lenders, investors, or tax man with the income statement for your business. It’s in interpreting the report and informing decision-making going forward. There are a few ways to go about this.
- Vertical analysis: Every line item gets converted into a percentage of total revenue so you can spot where costs are disproportionate.
- Horizontal analysis: The same line items get compared across multiple periods to look at trends. Is COGS growing faster than revenue? Is marketing spend producing diminishing returns? Etc.
Another reason to manually calculate your income statement on a regular basis is to catch errors before they compound into a bigger mess. That being said, you can simplify the entire process with GlassJar.
Simplify Financial Oversight With GlassJar
Knowing how to calculate income statement figures yourself is still worthwhile, but why work harder when you could work smarter? GlassJar transforms your transaction data into clean, formatted income statements without making you jump through hoops.
Whether you’re tired of the same old QuickBooks complaints or just want a better NetSuite alternative or FreshBooks alternative, learn more about what GlassJar can do for you today!
