How to prepare an income statement in 7 steps with examples

An income statement is one of the key financial documents for any organization, offering a straightforward glimpse into the inner workings of your business. From total revenue generated to how much you pay each month to keep the lights on, the income statement records earnings and expenses down to the last penny, so you can slice and dice the data and understand how to drive growth or control costs. 

Ready to prepare an income statement from scratch? We’ll walk you through the process, from the financial information you’ll need to collect to the standardized accounting formulas to apply.

What is an income statement?

An income statement is a financial document that summarizes an organization’s revenues, profits, expenses, and losses over a given period, usually quarterly or annually. Sometimes called a profit and loss statement (or a P&L), it provides a snapshot of an organization’s overall financial health. 

Almost all for-profit businesses will prepare income statements as part of their bookkeeping, but they can also be useful for non-profit organizations to track cash flow.

What is the purpose of an income statement?

An income statement helps stakeholders identify trends, monitor profitability, and make informed decisions about budgeting and spending.

Who uses an income statement?

Both internal and external stakeholders use income statements, albeit in different ways. For executives and managers, the information in an income statement can guide decisions on allocating resources or controlling cash flow. Investors and banks may scrutinize an income statement before offering funding or a loan to predict potential returns or calculate interest rates. 

What are the uses of income statements?

Organizations use income statements to monitor performance, guide financial decisions, and maintain compliance. Specifically, decision-makers can leverage the information in an income statement to track earnings in relation to spending and make strategic decisions based on an objective cost-benefit analysis. 

What should an income statement include?

The nature of your business and the complexity of its finances will determine the specific line items in your income statement. For example, a financial services company that invests on behalf of customers will need to include information about interest earned from its holdings, while a real estate developer will include more detail on asset sales and depreciation.

That said, a typical income statement for a company that sells goods or services will always include the following: 

• Gross sales. Total sales revenue before any adjustments or deductions.
• Costs of Goods Sold (COGS). The direct cost of providing goods or services.
• Gross income. Revenue minus the cost of goods sold, also known as gross profit.
• Operating expenses. Costs associated with day-to-day business operations.
• Operating income. Income after deducting operating expenses but before taxes.
• Tax expenses. Amounts owed in corporate income taxes.
• Net income. Final profit after deducting all taxes and expenses.

7 Steps to prepare an income statement

You’ll find most of the information needed to perform these calculations in your organization’s general ledger, expense reports, revenue records, and tax filings. 

If your organization doesn’t have a dedicated finance and accounting professional, financial management tools like Rippling can streamline the process of collecting this information.

Step 1. Calculate the total revenue for the chosen period

Start by adding together all the revenue figures for your reporting period. Remember, these can include revenue earned from interest, asset sales, and other income streams in addition to sales of goods and services. 

Example: During the first financial quarter of the year, Acme Corp. earned $500,000 in sales of goods and $1 million from the sale of a transport facility. Acme Corp.’s total revenue for the quarter amounts to $1.5 million.

Step 2. Calculate the expenses and the Cost of Goods Sold (COGS) 

COGS accounts for the labor, material, and production costs of producing goods for sale. If you run a service-based business, you’ll calculate the Cost of Services Sold (COSS) by adding essential expenses like subcontracting, supplies, or labor.

Example:  Acme Corp. purchased $100,000 of raw materials and paid artisans $50,000 in compensation to produce goods sold during the quarter for a COGS of $150,000. 

Step 3. Calculate gross profits 

Once you have total revenues and COGS, you can calculate your gross profit. This number represents the money made from sales of goods (or services) after deducting the costs associated with manufacturing and delivering them.

Example: With total revenues of $1.5 million and COGS of $150,000, Acme Corp. can report gross profits of $1.35 million.

Step 4. Include operating expenses

Most organizations have certain recurring expenses associated with staying up and running, such as office equipment, marketing, or rent. The specifics of this category will depend on the nature of your business, but the general rule of thumb is that if you need it to keep the organization in operation, you should include the expense. 

Compensation makes up a large part of operating expenses for many businesses and can significantly impact your total net income. Be sure to remove any pre-tax deductions before adding this line item. 

Example: Acme Corp. spent $12,000 to maintain a co-working space in Atlanta and $1,500 on printing and office supplies. The company also works with a marketing consultant and a legal advisor whose retainers amount to $18,000. Acme Corp.’s operating expenses total $31,500 for the quarter. 

Step 5. Determine earnings before taxes

Now that you’ve tallied how much money your organization made and spent, you have the information you need to calculate its income before taxes. To find it, subtract your COGS and operating expenses from your total revenue. 

Example: Acme Corp. posted total revenues of $1.5 million, COGS of $150,000, and operating expenses of $31,500 in the first quarter. Its earnings before taxes for this period are $1,318,500.

Step 6. Include income taxes

Of course, your company will need to pay income taxes on those earnings. The method of calculation and the amount will vary based on your location, as different jurisdictions apply different rates. The good news? This is the final deduction you need to calculate your organization’s net income.

Example:  Acme Corp. is headquartered in Atlanta, Georgia, which does not charge corporations income tax. That means the company only needs to worry about federal and state income taxes. 

Acme Corp. will pay 21% of its pre-tax income to the IRS and 5.39% to the Georgia Department of Revenue for a total tax obligation of $347,952.

Step 7. Calculate net income

By this point, you have all the information you need to calculate your organization’s net income. This number represents the total earnings after deducting all taxes and expenses from your revenues and is a key indicator of financial health.  

To find your organization’s net income, subtract any income taxes owed from earnings before taxes.

Example: Acme Corp. reported $1,318,500 in pre-tax earnings and paid $347,952 in income taxes, so the company can claim a net income of $970,548.

Income statement example

Even a straightforward income statement can seem confusing, particularly if you’re unfamiliar with the terminology or unclear about the relationship between various figures. Formatting this financial statement correctly can help avoid confusion and present your organization in the best, most accurate light. 

The income statement example below sets out the financial information for Acme Corp. in a clean, easy-to-follow structure.

Simplify your finance processes

What’s the best place to locate information to prepare an income statement? Your general ledger. This comprehensive financial report contains information about every transaction, from employee expenses to operational costs to payroll tax payments.

Rippling Spend streamlines income statement preparation by consolidating your finances—from payroll to corporate cards and expense reimbursements–and automatically syncing transactions to your general ledger. Accountants can close the books with ease. And finance leaders can use the up-to-date spend data to produce income statements. 

FAQs

What goes on an income statement?

An income statement includes key financial data points summarizing a company’s performance over a period. It will include revenue, sales, costs of goods or services, operating expenses, and tax calculations.

Which accounts are found on an income statement?

Common accounts on an income statement include COGS, operating expenses, operating income, taxes, and net income. Depending on the complexity of a business’ balance sheet, however, accounts may be much more sophisticated.

How do you create an income statement?

To create an income statement, define a specific period of time on which to report. Next, gather information on revenues, sales, expenses, and taxes. Use this information to calculate total revenues, gross profits, pre-tax income, and net income.

This blog is based on information available to Rippling as of October 10, 2024.

Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.