How to Prepare an Income Statement for Accurate Financial Reporting

Key takeaways

An income statement shows a company’s net income, which factors in revenue and expenses, for a given period—typically for a month, quarter, or year. Here are some important facts to know:

• Income statements, along with balance sheets and cash flow statements, provide companies and stakeholders with a view of the business’s financial health. The data can help inform ongoing strategies and enable the team to learn from both successes and challenges. 

• Single-step income statements offer simple preparation with a focus on net income, while multi-step income statements provide more detailed financial information, making them ideal for corporations and smaller businesses that need to demonstrate their financial health to investors or creditors. 

• You can use small business accounting tools and software like Intuit QuickBooks to help streamline the income statement preparation process. 

Learn how to prepare an income statement, with step-by-step guidance and insight into the difference a well-prepared income sheet can make. If you’re ready to learn more, consider enrolling in the Intuit Academy Bookkeeping: Balance Books Like a Boss Professional Certificate. In this four-course series, you’ll become more familiar with working with income statements and other financial reporting, conducting financial statement analysis, and working with accounting software. 

What is an income statement, and why is it important? 

An income statement is one of the three main financial documents businesses use to get a view of their financial health. The others are balance sheets, which list assets and liabilities for a specific point in time, and cash flow statements, which offer insight into how the company produces and uses cash in a specified period.

Income statements, sometimes called profit and loss or “P&L” statements, provide insight into the business’s profits and expenses, ultimately detailing the net income produced for the given time period. Typically, companies prepare these documents on a monthly, quarterly, or annual basis to provide owners and managers insight into the profitability of business activities. It also illustrates what’s working and areas in need of improvement. 

For example, you could create separate income statements for each major department or product line to see where the company’s earnings are the strongest. Or, you might use the insights to reallocate resources and change your pricing strategy to increase revenue. 

Uses for an income sheet

Income sheets provide information that managers, entrepreneurs, and stakeholders can use to drive better decisions. Income statements can also help you decide where to cut expenses, areas to invest more resources into, and see how you can use resources more efficiently to improve profitability moving forward. 

These documents can help boost morale by demonstrating how specific projects, products, and services contribute to profits. They can also help align departments and teams across the company by giving everyone a deeper understanding of the company’s financial well-being. 

How to prepare an income statement step by step: A detailed view 

Businesses of all sizes use income statements to remain compliant with tax regulations, assess how the business is doing in terms of generating a profit, and make informed projections regarding future revenue. Whether you prepare a simple (single-step) or more complex (multiple-step) income sheet, the basic process remains the same. Examine each step in more detail to understand the process and become more familiar with this essential financial report. 

1. Define the reporting period

You can create monthly, quarterly, or annual reports. A monthly income sheet can provide a consistent view of performance over time and give you the flexibility to resolve any issues sooner than with quarterly or annual income sheets. However, quarterly and yearly reports offer more clarity regarding performance over time, making them equally valuable, particularly for understanding long-term trends.

2. Gather revenue data

Revenue is essentially the amount of money you’ve taken in during the reporting period. This money typically falls into one of two categories: operating and non-operating revenue. Operating revenue consists of the money generated by the business’s primary functions. 

So, if you sell furniture, for example, your operating revenue would come from the sales you made during the time you’re reporting on. Non-operating revenue comes from secondary business activities, like royalties earned through partnerships, renting business properties, or interest on capital in the bank. 

3. Add up any gains accrued during the period

Gains refer to money you might make from other non-business activities. Selling an asset, like a business property, increased business value from investments, and proceeds from successful lawsuits may all fall into this category. 

4. Add up expenses

Like revenue, expenses fall into several categories. Primary expenses are those that you accumulate for the business’s primary activities—those incurred while earning operating revenue. These costs could come from areas like research and development, wages for employees, utilities, and transportation. The cost of goods sold (COGS) also falls under primary expenses. COGS represents the costs of producing the products or associated with providing the services your company offers. Secondary expenses could come from sources like interest you pay on business loans, for example. 

5. Add up losses

Losses refer to expenses outside of your primary business operations. Examples could include the money lost on a failed investment or that paid as a result of a lawsuit. 

6. Calculate net profit

Now that you’ve got your metrics and data points gathered, you can perform the final calculation to finish your income sheet. Add total revenue and gains, add total expenses and losses, and subtract the two. The formula looks like this: 

(total revenue + gains) - (total expenses + losses) = net income

Read more: What Are Accrued Expenses? Examples, Benefits, and How to Record Them

Types of income statements and when to use each

You can choose from two types of income statements, depending on the level of detail you need. Both track profits and expenses, and each has its own advantages. Learn more about each to determine which might be right for your needs. 

Single-step income statement

Best for: Small businesses, entrepreneurs; use for basic details and at-a-glance information

Like its name implies, a single-step income statement is simple and straightforward. It includes revenue, expenses, and net income. Because it focuses only on net income, it’s easy to prepare and ideal for use when net income is the only consideration. However, when stakeholders require more information to assess the company’s financial health, such as when meeting with investors who may prefer additional data points, this approach may be overly simplified, making a multi-step income statement a better fit. 

Multi-step income statement

Best for: Corporations, small businesses presenting to investors; use for detailed financial information

These income sheets go beyond just net income, offering additional details like operational and non-operational costs, to provide a more holistic view of the business’s operating, gross, and net profit margins. In doing so, multi-step income statements help demonstrate how the company leverages its resources, including labor and supplies, to generate income. It also illustrates the efficiency with which the company’s primary activities produce revenue. Corporations and publicly traded companies typically use this type of income statement. Small businesses and entrepreneurs may also use it when meeting with investors or creditors.

How to prepare a balance sheet from an income statement

The ending point of your income statement, net income, flows into the beginning of your balance sheet, which starts with net income and operational cash. This document, when combined with an income statement or cash flow statement, provides a holistic view of the company’s financial health for the specified timeframe.

To prepare a balance sheet, start by identifying the reporting period. Then: 

1. List current assets, including the net income from your income statement, and noncurrent assets, such as property and long-term securities.

2. List liabilities, which may include accounts payable and non-current liabilities like long-term debts or lease obligations.

3. List shareholders’ equity.

4. Add liabilities and shareholder equity, and compare the figure to assets.

Who uses income statements?

Income statements provide valuable information for accountants and financial professionals. Entrepreneurs, business owners, investors, and managers also often use these documents to gain a clear view of trends over a set period, assess the company’s financial health, and make informed financial decisions. 

Users typically fall into one of two categories: internal and external. Check out how different users utilize these documents.

Internal users

This group encompasses business owners, the organization’s management team, and its board of directors, if it has one. Internal users leverage the information to assess where the company stands, address cash flow challenges, and make decisions that can support greater profitability. Income statements also help internal users: 

• See the impact of the company’s efforts on its revenue.

• Assess financial missteps and course-correct as needed.

• Inform decisions surrounding planning and managing the budget.

• Ensure interdepartmental alignment. 

• Motivate employees, teams, and stakeholders by demonstrating the impact of projects and productivity.

External users

In addition to the people working within your company, those outside of it, including investors and creditors, can also use your income statement. In these cases, it often becomes a tool that helps them assess whether to invest in your business. Creditors’ research analysts can use your income statement to compare quarterly and yearly performance to get a clearer view of whether your business is positioned for growth and future profitability. Additionally, competitors might use your income statements to determine how successful your business is or to investigate areas you might be spending more or less than they are. 

Tools and templates to simplify income statement preparation

Technology offers several ways to streamline the preparation process, including the use of software, templates, and even artificial intelligence (AI). For instance, you can find free templates that you can download using accounting websites like FreshBooks or Smartsheet. You can also use spreadsheets, including Microsoft Excel or accounting software like Intuit QuickBooks. 

AI can help with efficient data extraction and create financial reports to make calculating revenue, expenses, and other relevant data points faster and less prone to human error. You might even run your metrics through AI-powered analysis to identify any anomalies and ensure you’re working with clean data. 

Read more: Machine Learning in Finance: 10 Applications and Use Cases

Explore free resources to build your financial skills

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• Take a quiz: Career Test: What Career Is Right for Me Quiz?

• Watch a video on YouTube: The Accounting Courses Every Founder Needs

• Sharpen your Excel skills: How to Use Dynamic Named Ranges in Excel

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