HOW TO PREPARE AN INCOME STATEMENT: Definition, Format, & Step-by-Step Guide

Income statements are an important aspect of any business and one of the three parts of a financial statement that include a balance sheet and a cash-flow statement. This means that if you ever want to experience what real success feels like in the business world, you’d need to be able to read one and learn how to prepare it. This post highlights every aspect of the income statement process and steps to follow when you need to prepare one. We will also go over an example of the income statement document and the format to follow when you want to prepare one in Excel.

How to Prepare an Income Statement

An income statement is an important document for every business or financial organization. The income statement typically contains the revenues, and expenses that result in the profit or loss of a business. An income statement is one of the three components that make up a complete set of financial statements. The other two reports that make up a financial statement of a business include the balance sheet and statement of cash flows.

However, in order to properly prepare a financial statement, you must know how to properly prepare an income statement. This is not a difficult task only if you know the steps.

Step-by-Step Format for Preparing an Income Statement

The following steps will show you how to prepare an income statement.

#1. Get the Trial Balance

You can go to the accounting software and print the “trial balance” standard report. This simply means a summary report that contains the ending balance of every account in the general ledger.

#2. Know the Revenue Amount

Aggregate all of the items on the revenue line, which is on the trial balance, and then insert the result into the revenue line item in the income statement.

#3. Determine the Cost of Goods Sold Amount

Total all the cost of goods that are on the sold line items on the trial balance. And, insert the result into the cost of goods on the sold line item in the income statement. The cost of goods sold now typically includes the costs of direct labor, direct materials, and factory overhead. This is in line position directly below the revenue line item.

#4. Calculate the Gross Margin

This step entails that you subtract the cost of goods sold from the revenue figure, in order to arrive at the gross margin. The gross is typically the amount earned on the sale of products and services.

#5. Determine Operating Expenses

In this step, you need to total the expense items on the line below the cost of goods sold in the trial balance. Furthermore, insert the result into the selling and administrative expenses line item in the income statement. This line is directly below the gross margin line.

#6. Calculate Income

In this step, subtract the selling and administrative expenses from the gross margin to arrive at pre-tax income. Then, insert this calculation at the bottom of the income statement.

#7. Calculate the Income Tax

In order to calculate the income tax, you have to multiply the applicable tax rate by the pre-tax income number. which enables you to typically arrive at an income tax expense. Then, enter the amount below the pre-tax income number, and record it in the accounting records with a journal entry.

#8. Calculate Net Income

In this step, subtract the income tax from the pre-tax income figure, and then enter the amount on the last and final line of the income statement as the net income figure. Also, include net income as a percentage of revenue.

#9. Prepare the Income Statement Header

Your income statement needs to contain a header that you typically identify as an income statement. The header includes the following: the name of the business and the date range that the income statement covers. Which is either for a month, quarter, or year.

It’s important to note that all accounting software has a standard income statement report that automatically presents the information required as in the above steps. However, these steps only contain actions in which you are required to manually shift income statement information from the trial balance to a manually prepared income statement. 

Example of How to Prepare an Income Statement 

As I explained above, an income statement is a financial report that explains a company’s income and expenses over a reporting period. However, an example of how to prepare an income statement may vary by business type. You can also refer to the income and expenses as a profit and loss (P & L). Income statements show a company’s financial performance over a reporting period. This is because the income statement contains and shows revenues and expenses, providing a look into which business activities brought in revenue and which cost the organization money. 

Importantly, when it comes to financial statements, each statement communicates specific information and is very essential in their different contexts in order to understand a company’s financial health. However, the income statement is one of the most important financial statements. This is because it details a company’s income and expenses over a specific period as well as communicates a wide range of rich information to those reading it. From the information ranging from key executives and stakeholders to investors and employees, being able to read an income statement is important. Knowing how to prepare or generate one is even more critical. 

Income Statement Terms

We previously discussed the steps you need to follow in order to prepare an income statement. Now we typically want to follow those steps in order to show you an example of you should prepare an income statement. Meanwhile, before we dive into an example of how to prepare an income statement. I want you to be aware of the meaning of some terms you will see and use in this statement. This term includes;

• Revenue: This means how much money a business got during a reporting period
• Expenses: Oppositely, this is how much money a business spends during a reporting period.
• Costs of goods sold (COGS): the total costs associated with the component parts of whatever product or service a company makes and sells.
• Gross profit is simply the revenue minus the cost of goods sold.
• Operating income: This means gross profit minus operating expenses.
• The operating income is subtracted from the non-operating expenses.
• Net income: This means income before taxes.
• Earnings per share (EPS): Earnings per share means the net income divided by the total number of outstanding shares.
• Depreciation: The loss in value of assets, such as inventory, equipment, and property, over a period of time
• EBITDA: This typically means earnings before interest, depreciation, taxes, and amortization 

Follow the example below to understand how you should prepare an income statement for your business. Most people also understand ideas when they are in picture form. This is because they are fun and easy to understand.

This is an example of an income statement for Maxwell Ltd.

Income statement for Maxwell Limited for the period ending December 31st, 2021

How to Prepare an Income Statement in Accounting 

An income statement is another name for a small business owner’s profit and loss statement. It is also one of the three financial statements that businesses usually prepare at the end of a financial year. While others include the balance sheet and statement of cash flows.

This statement can be presented in a “one-step” or “two-step” format. Firstly, the “one-step” format contains revenues and gains that are grouped together, while the expenses and losses are also grouped together. Then, the amounts are totaled to show net income or loss. Secondly, in the “two-step” format, you use the subtotals to show decisions that are useful in the line. This includes items such as gross margin and operating income. However, separately from the non-operating income and net income or loss. 

A lot of commercial industries and big organizations or reporting entities use a “two-step” format. Although the one and two steps above are the most common ways businesses report their financial state, they can also present an income statement by its function.

For example, the cost of sales, selling expense, administrative expense, or by its nature, examples, payroll expense, advertising expense, and rent expense. This approach may be easier to prepare an income statement in accounting for most people as well as in most cases. However, it does not present the cost of sales, therefore, the gross margin is not determined.

How to Prepare an Income Statement and Balance Sheet

The company’s financial statements typically give you a glimpse of the financial situation of your company or business. Therefore, without them, you won’t be able to track your revenue, project your future finances, or even keep your business on track. As much as you need to know how to prepare the income statement, it’s also important you master the balance sheet because they work together.

You typically need the knowledge of the two accounts because you can’t just go off and create different financial statements without following the right procedure. You would, however, not arrive at the correct result.

As we have been discussing, an income statement, which you can also call a profit and loss statement (P&L), reports the business’s profits and losses over a specific period of time. (e.g., monthly, quarterly, etc.). The income statement begins with sales and ends with net income or loss. Other parts of an income statement include:

• Revenue
• Cost of goods sold
• Expenses
• Taxes
• Gross profit
• Depreciation
• EBIT/EBITDA
• Other financial gains and costs

The Basis of a Balance Sheet and How to Prepare an Income Statement

A balance sheet is one of the statements that constitute the financial statement of a business. A balance sheet simply tracks your financial progress over time, and there are three different parts of a balance sheet, which include;

• Assets
• Liabilities
• Equity

Now, assets mean items of value and things that your business owns, like vehicles and inventory. These assets can also be in the form of current and non-current assets. Current assets are items that are of value and can typically be converted into cash within one year, like a checking account. Then, non-current assets are items that are of value but take more than one year to convert into cash.

Liabilities are the debts you owe to other people, like businesses, organizations, or even agencies. Your liabilities can be in the form of current (short-term) or non-current (long-term). Examples of liabilities include accounts payable, accrued expenses, and long-term loan debt.

Equity means everything you own, after subtracting your liabilities and debts. You can determine your equity by using this formula:

Equity = Assets – Liabilities

The income statement comes first in the financial statement, followed by the balance sheet, and then, lastly, the cash flow statement. This is typically why you also need to know how to prepare the balance sheet alongside the income statement. Meanwhile, there are people who believe there are four major parts of a financial statement, including the statement of retained earnings, which comes before the balance sheet. However, this is not popular or widely accepted.

How to Prepare an Income Statement in Excel 

One of the most popular questions on the internet today is how do I prepare an income statement in excel? However, I would like to clarify the fact that you need to have knowledge of how to prepare an income statement manually or at least have an idea of it before diving into excel.

As long as you’re a business owner, which most people are in recent times, you need to have this knowledge in a digital world. This is because you need to track the performance of your business over a period in order to make good financial decisions in the future. Excel can help you create and improve your financial statements only if you follow the right steps, and these steps include.

Entering the Details of an Income Statement into an Excel Sheet

We are going to look at the basic steps we need to follow in order to prepare a good income statement and then other steps you need to follow when you need to put them into excel. They include;

• Choose your period (monthly, annually, or quarterly).
• Have a journal at hand for proper and accurate record-keeping 
• Arrange your work in the right categories before forwarding them to excel.
• Create the excel file: In order to make an excel file, you need to open Microsoft Excel and create a new file. In the first cell, type in your company name. Because it helps to organize your files, then, skip a row and then write the period you are covered in the statement.
• Find the subcategories: The categories remain the same everywhere. However, the section changes from business to business. This is why you need to find the section that best defines or is similar to your business. Arrange the works by re-sizing these columns to fit, indent each section to differentiate; always add space.
• Get your formula ready: Already having the knowledge of which section to add up and subtract, you only need to use the sum key in excel to arrive at your different results for each section.

Read Also: MULTI-STEP INCOME STATEMENT: Examples, Format & How-to Guide

• Format your file: To ensure your document is easy to read, you need to format your document. Follow these simple steps.
• Choose more number formats
• You will see a new window titled “Format Cells”. then, look for the number tab at the top of the row.
• Click on it, then, under the category sub-window, choose currency.
• Find the correct symbol that represents your currency accurately.
• Afterward, under the negative numbers sub-window, select the -$1234.10 with a red font color option.
• Add your values: After you’ve prepared everything, place all the actual values that you’ve prepared. And also, all the amounts you entered should be positive unless it’s for a row that’s marked, less.

What is the income statement draw format?

The name of the business, the phrase “income statement” in the title, the time period covered, and other important information are all included in the income statement format. Amount (Rs.) Amount (Rs.) Revenue from services, sales of items, royalties, rentals, interest, commissions, etc.

What are the 5 main components of the income statement?

Revenue, costs, and net profit are all listed on the income statement. Revenue, cost of sales, sales, general, and administrative expenses, other operating expenses, non-operating income and expenses, gains and losses, non-recurring items, net income, and EPS are the elements of the income statement.

What are the 3 most important things on an income statement?

This is the amount of money you make before taxes. Gross profit, which is the company’s profit, is determined by deducting the cost of items sold from revenue. Net income: Net income is the amount of money that remains after deducting all of your costs from your gross earnings.

What 3 things does an income statement show?

An income statement displays the revenues, costs, and profitability of a business over time. It is also sometimes referred to as an earnings statement or a profit-and-loss (P&L) statement.

How do you record income and expenses?

Items of income and expense are documented in nominal ledger accounts in accordance with established regulations, just as assets and liabilities. In expense accounts, expenses are always recorded as debit entries, while income items are always recorded as credit entries.

Conclusion

I believe that through the aid of this post, you already understand how to prepare an income statement for any purpose you need it for, and most importantly, how to prepare it in excel. You can’t doubt that the world is digitizing and we need to move with it.

Therefore, this post has given you a complete guide on how to prepare the basic accounting income statement for your business with a balance sheet and excel knowledge as well.

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