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How to prepare an income statement for a small business

A small business owner sitting at her kitchen table uses a laptop to prepare an income statement.
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An income statement details revenue and expenses to provide insights into a business’s financial performance during a period of time. 

Read on to learn what an income statement is, what it includes, why it’s important, and how to make an income statement for your small business. We’ve even included a free small business income statement template you can use.

What’s an income statement?

Also referred to as a profit and loss (P&L) statement, an income statement is one of three main financial reports a business of any size needs to prepare, alongside the balance sheet and cash flow statement.

An income statement gives insights into your business’s operations, how efficiently it is being managed, what departments are underperforming, and how well it’s doing compared to the competition.

The income statement calculates the company’s net income or net profit by taking into account its earnings, gains, expenses, and losses over a period. A balance sheet, on the other hand, only lists the fiscal situation on a specific date.

Unlike a cash flow statement, an income statement includes the full sums of all sales and purchases, whether they were done in cash or credit. This means that an expense is listed in full, even if you’re paying for it in installments or with net terms after the end of the reporting period. The same goes for revenue, which is listed whether it was collected yet or not.

Why is an income statement important?

A properly prepared income statement gives business owners a clear picture of the company’s financial position.

Using the income statement, a business owner can adjust their business plan according to the company’s actual performance. They can also explore which business activities produce the most revenue and profit 

to assess their viability and contribution to the business’s overall health.

An income statement is also a viable tool for figuring out the balance between expense management and additional investment. In other words, which expenses can be cut back and where you should invest more. And, it helps find areas for improvement, for example, a business activity that has potential but is suffering from inefficiencies.

What’s included in an income statement

When you prepare an income statement, there are four main categories to take into account: revenue, gains, expenses, and losses.

These are used to calculate the company’s gross profitProfitProfit is the earnings that remain after you deduct expenses from revenues. Net profit is what’s left when all types of expenses are deducted from sales. Gross profit is what’s left after deducting the costs associated with making and selling the products, or the costs associated with providing services. and net income for the reporting period.

Revenue

Revenue includes:

  • Operating revenue. This refers to revenue directly linked to sales from your primary business activities. Depending on your industry and specialties these can be goods, services, or both. For example, if you own a coffee shop, all the coffee, pastries, and teas you sell at the shop, go into your operating revenue.  
  • Non-operating revenue. Recurring revenue driven from secondary non-core activity. This can be for example, from interest on your savings in the bank, renting out unused space, selling branded merchandise, or ad space in public areas of your establishment. If we go back to the coffee shop example, the money from ads hanging in the bathroom or from selling reusable takeaway cups goes under non-operating revenue.
  • Returns and concessions. This item has a negative value as it represents sales that have been canceled for whatever reason and need to be deducted from your revenue.

Gains

Unlike revenue, gains refer to non-recurring income. It is typically generated not from the sale of goods or services but from other non-core business activities such as the sale of a branch, property, and used equipment or winning a lawsuit or insurance claim. 

These are relatively rare activities, especially for a small business, so they may not apply for every period.

Expenses

All money spent during the reporting period including:

  • Cost of goods (COGS). The total costs directly associated with producing or acquiring goods for sale or providing a service.
  • Operating expenses. Costs directly linked to sales related to your primary business activity. This includes marketing, payroll, packaging, etc.  
  • Non-operating expenses. All expenses not directly related to the core activity but essential to the general management of the company. For example, cleaning, rent, overhead, office supplies, etc.
  • Income tax. The total amount of taxes owed for the business’s income during the reporting period.
  • Interest. The total amount of interest your business incurred for loans and other forms of debt over the period.

Losses

Losses can include: 

  • Depreciation. The lost value of assets over time due to wear and tear, outdated technology, or other factors. Depreciation is a percentage of the asset’s original cost that is deducted every year to reflect this decline.
  • Legal remedies. Losses that occur when a company loses a court case or reaches a settlement requiring it to pay another party.

How to create an income statement

Before you can start preparing your income statement, you first need to figure out two things:

Your reporting period

Income statements are usually produced for a 12-month period but some companies may choose shorter time spans, for example, quarterly or even monthly statements. 

A longer reporting period gives a better picture of your business performance without the fleeting effects of seasonality.

A shorter period, on the other hand, gives you more oversight for quickly adjusting your strategy according to the performance. During times of transition, it may be beneficial to produce more frequent reports.

When deciding your reporting period, also examine when it should begin or end. For simplicity, many businesses choose to do annual reports beginning January 1st and ending December 31st.

However, companies sometimes define their fiscal year independently from the calendar year. This means, for example, that their annual report may cover a year ending on June 30th instead.

Regardless of what you choose, it’s important to clearly state your reporting period at the top of your income statement.

The type of income statement you need

There are two types of income statements:

A single-step income statement in which all expenses and losses are bundled together and deducted from all revenues and gains.

A multi-step income statement in which you separate operating income and expenses from non-operating income and expenses to get a better picture of the performance of your various business activities.

Generally speaking, a single-step income statement is usually enough for small and medium-sized businesses (SMBs) that have a simple business structure and a single core activity.

A multi-step statement would be a better fit for larger businesses with diverse business activities and multiple departments.

That said, if your SMB is looking to secure a loan or any other type of financing, you may be required to produce a multi-step statement as well.

How to create a single-step income statement

Contrary to what the phrase single-step might suggest, there are a few steps you need to take to prepare your income statement: 

  1. Add up all your revenue and gains.
  2. Add up all your expenses and losses.
  3. Deduct your expenses and losses from your revenue and gains to reach your income before tax and interest (EBIT). 
  4. Add up your tax and interest.
  5. Deduct tax and interest from EBIT to reach net profit.

How to create a multi-step income statement, one step at a time

As you’ve probably already figured out, a multi-step statement has a lot more steps.

Here’s how to do an income statement using the multi-step method:

Step 1: Operating revenue
Add up all your revenue from sales during the reporting period and deduct your returns and concessions.

Step 2: Cost of goods sold (COGS)

Add up all expenses directly related to the manufacturing or acquisition of goods sold or the provision of services to determine your COGS. 

Step 3: Gross profit

Deduct your COGS from the operating revenue.

Step 4: Operating expenses

Add up all operating costs incurred in the reported period. Remember that this should not include COGS, which are already accounted for. 

Step 5: Total operating income

Deduct the operational expenses from your gross profit.

Step 6: Non-operating revenue

Add up all income from non-core activities. 

Step 7: Non-operating expenses

Add up all expenses for non-core activities.

Step 8: Non-operating income

Subtract non-operating expenses from non-operating revenue.

Step 9: Gains and losses

Add up all your gains then deduct your losses.

Step 10: Income before tax and interest (EBIT) 

Add gains and losses to non-operating income and operating income to reach your EBIT.

Step 11: Taxes and interest

Add up the income tax for the reporting period and the interest incurred for debt during that time.

Step 12: Net profit

Subtract the taxes and interest from your EBIT to reach net profit. 

Small business income statement template

Handling financial statements can be overwhelming for anyone, especially small business owners who are more passionate about serving their customers than about spreadsheets and numbers.

To save you time, we’ve prepared an income statement template for small businesses to leverage.

It comes in a spreadsheet format (.xlsx) that you can open with Microsoft Excel, Google Sheets, or any other compatible spreadsheet program you’re used to.

In the file, you’ll find two sheets to choose from: one for a single-step income statement and the other for a multi-step statement. All you have to do is fill out your company’s information. We’ve already put in the formulas so all the calculations are done automatically.

Feel free to change the description of the items to fit your business. You can also add or delete lines as needed.

Download the free small business income statement template here.

Download

Income statement examples

In case you’re confused, here are examples of what an income statement using both methods would look like for a pet supply store called Rocky’s Pet Supplies. 

We used Melio’s income statement template to create both versions. As you can see, the numbers are the same but the way they are presented is quite different.

Example of a single-step income statement

Here’s what Rocky’s Pet Supplies’ single-step income statement for 2023 looks like.

A single-step income statement example for fictional business Rocky's Pet Supplies.

Example of a multi-step income statement

Here’s what Rocky’s Pet Supplies’ multi-step income statement for 2023 looks like.

A multi-step income statement example for fictional business Rocky's Pet Supplies.

Keep your business organized for easy reporting

Using an online payment platform like Melio to pay your business bills makes it easy to find all your expenses when it’s time to make an income statement. Sign up for Melio today to start sending digital payments to all your vendors.

P.S. Don’t forget to pick up our small business income statement template.

Download

*This blog post is intended for informational purposes only and is not intended as financial advice.
**Melio does not provide legal, tax or accounting advice, and you should consult with a professional advisor before making any financial decisions.

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