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What Is an Income Statement? A Guide for Small Business Owners
One of the best ways to understand your small business's profitability and financial performance is to review an income statement. This financial report helps you see how much revenue your business generates, what it spends, and whether it earns a profit or experiences a loss during a specific period.
Whether you operate a service business, retail store, or growing company, an income statement can help you evaluate performance, prepare budgets, identify opportunities to reduce expenses, and make informed business decisions. Banks, lenders, and potential investors may also request financial statements when evaluating a business.
In this guide, you'll learn what an income statement is, what information it includes, how to interpret its results, and why it is an important financial tool for small business owners.
What Is an Income Statement?
An income statement is a financial report that summarizes a business's revenues, expenses, gains, and losses over a specific period. It shows whether the business generated a net profit or incurred a net loss during that time.
An income statement is also commonly called a profit and loss statement (P&L), a statement of operations, or an earnings statement.
Businesses can prepare income statements monthly, quarterly, annually, or for another defined reporting period. Reviewing the report regularly helps owners monitor financial performance and compare results across different periods.
For example, a business might prepare an income statement for January to determine whether its revenue covered operating expenses. At the end of the year, the owner can review the annual statement to evaluate overall performance and identify trends.
What Does an Income Statement Show?
An income statement shows how revenue and expenses affect a business's profitability. Its final figure, known as net income or net profit, represents the result after the applicable expenses and losses are deducted from revenue and gains.
A typical income statement may include:
Revenue: Income generated from selling products or providing services.
Cost of goods sold (COGS): Costs directly associated with goods sold, when applicable.
Gross profit: Revenue remaining after subtracting the cost of goods sold.
Operating expenses: Costs of running the business, such as rent, salaries, utilities, and marketing.
Operating income: Profit from the business's main operations before applicable non-operating items and taxes.
Non-operating income and expenses: Items outside the business's primary operations, such as certain interest income or interest expenses.
Income tax expense: Applicable income tax expense recognized in the financial statements.
Net income or net loss: The final result after accounting for the applicable income and expenses.
Not every income statement includes all these categories. The format depends on the business, its activities, and the accounting framework used.
Income Statement Example for a Small Business
Consider a hypothetical small business that provides services. The following example illustrates a simplified income statement for one month.
Illustrative amounts in U.S. dollars. This example is for educational purposes and does not represent an actual company's financial statements.
Income Statement
Amount
Revenue
$25,000
Cost of services
$7,000
Gross profit
$18,000
Operating expenses
Salaries and wages
$6,000
Rent and utilities
$2,000
Marketing
$800
Software and office expenses
$700
Total operating expenses
$9,500
Operating income
$8,500
Interest expense
$300
Income before tax
$8,200
Illustrative income tax expense
$1,640
Net income
$6,560
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In this example, the business generated $25,000 in revenue and reported $6,560 in net income for the month.
The results can help the owner evaluate whether expenses are reasonable, whether revenue is sufficient to support the business, and whether there are opportunities to improve profitability.
Actual financial statements may include additional categories, and the presentation of taxes and expenses depends on the business's accounting and reporting requirements.
What Goes on an Income Statement?
Income statements generally contain several key components. Understanding each one can help you interpret the report and identify which areas of your business are performing well.
Revenue or Sales
Revenue represents the income generated from a business's primary activities, such as selling products or providing services. It is generally shown near the top of the income statement.
If a company has multiple revenue streams, the statement may list them separately or combine them into a total revenue figure.
For example, a bookkeeping business might earn revenue from monthly bookkeeping services, payroll support, and consulting.
Cost of Goods Sold
Cost of goods sold represents the costs associated with products sold during the reporting period. Depending on the business, these costs may include inventory costs, raw materials, and direct production labor.
Service businesses may have direct costs associated with delivering services, although the terminology and presentation can differ.
Subtracting the applicable cost of goods sold from revenue produces gross profit.
Gross Profit
Gross profit is the amount remaining after subtracting the cost of goods sold from net sales or revenue, as applicable.
The formula is:
Gross Profit = Net Sales − Cost of Goods Sold
Gross profit helps business owners evaluate how efficiently they produce or acquire the products they sell. For service businesses, a comparable measure may be used to assess direct service delivery costs.
Operating Expenses
Operating expenses are costs associated with running the business. Common examples include:
Salaries and wages
Rent and utilities
Advertising and marketing
Insurance
Office supplies
Software subscriptions
Professional fees
Certain administrative expenses
Tracking these costs helps owners identify rising expenses and evaluate whether spending aligns with business goals.
Depreciation and Amortization
Depreciation allocates the cost of an eligible tangible long-term asset over its useful life for accounting purposes. Amortization generally applies to certain intangible assets.
For example, a business may recognize depreciation expense on qualifying equipment used in its operations.
Financial statement depreciation and tax depreciation may differ. The amount reported for accounting purposes is not necessarily the amount deductible on the business's tax return.
Interest and Other Non-Operating Items
Interest expense may arise from business loans, lines of credit, or other borrowing arrangements. Other non-operating items can include certain gains, losses, or income not directly related to the company's primary activities.
Separating these items from operating results can help owners understand the profitability of their main business activities.
Income Taxes
Depending on the business structure and financial reporting method, an income statement may include income tax expense.
The tax expense shown in financial statements does not necessarily equal the amount paid during the period or the amount owed on a tax return. Some business structures also pass taxable income through to their owners, so the presentation can vary.
Net Income or Net Loss
Net income is the amount remaining after all applicable expenses and losses are deducted from revenue and gains. If expenses exceed the relevant income, the business may report a net loss.
This final figure is often called the bottom line because it summarizes the overall result for the reporting period.
Single-Step vs. Multiple-Step Income Statements
Businesses may use different income statement formats. Two common formats are single-step and multiple-step income statements.
Single-Step Income Statement
A single-step income statement combines revenues and gains into one total and expenses and losses into another total. It then subtracts total expenses and losses from total revenues and gains to calculate net income.
This format is relatively simple and may be useful for businesses that need a concise overview of financial performance.
Multiple-Step Income Statement
A multiple-step income statement separates operating and non-operating items and includes important subtotals, such as gross profit and operating income.
This format provides more detail about the sources of profit and the costs associated with the business's main operations. It can be particularly useful for companies that sell products or have several categories of operating expenses.
Neither format is automatically best for every business. The appropriate presentation depends on the company's needs and applicable reporting requirements.
What Is the Purpose of an Income Statement?
The purpose of an income statement is to help business owners and other users understand financial performance over a defined period.
Rather than relying only on the cash in a bank account, owners can use an income statement to evaluate recorded revenue, expenses, and profitability. Depending on the accounting method, some revenue and expenses may be recorded in a different period from when cash is received or paid.
An income statement can be useful for several reasons.
Monitor Financial Performance
Reviewing the statement monthly or quarterly helps you determine whether revenue and expenses are moving in the right direction.
Comparing periods can reveal changes in sales, cost of goods sold, payroll expenses, or other costs that deserve further attention.
Create and Evaluate Budgets
An income statement allows you to compare actual results with your budget. If marketing costs are higher than expected or revenue is below target, you can investigate the reasons and adjust your plans.
Support Business Decisions
Financial results can help owners decide whether to increase prices, hire employees, invest in equipment, expand services, or reduce unnecessary expenses.
For example, if revenue increases but net profit declines, the owner can review operating expenses and direct costs to identify what is affecting profitability.
Prepare for Financing
Banks and other lenders may request income statements, balance sheets, cash flow statements, tax returns, and additional financial documents when evaluating a loan application.
An income statement can help them assess revenue, expenses, and profitability. However, it does not guarantee loan approval; lenders consider other factors, including cash flow, existing debt, credit history, and repayment capacity.
Support Tax Preparation
Accurate income and expense records help businesses prepare tax returns and support the amounts reported. However, an income statement is not a substitute for a tax return.
Tax rules may treat certain income, expenses, depreciation, and other items differently from financial accounting rules. Businesses should reconcile relevant differences when preparing their tax filings.
Why Is an Income Statement Important?
An income statement is valuable because it transforms bookkeeping records into information that can guide business decisions.
Key benefits include:
Understanding profitability: Determine whether the business is earning a profit or experiencing a loss.
Identifying trends: Compare monthly, quarterly, and annual results.
Controlling expenses: Identify categories where costs are increasing or exceeding expectations.
Planning for growth: Use historical performance to support realistic budgets and financial projections.
Evaluating financing options: Provide lenders with information they may request when reviewing a loan application.
Supporting tax preparation: Organize financial information needed to prepare and substantiate tax reporting.
Improving accountability: Give owners and managers a clearer basis for evaluating performance against business goals.
The value of an income statement depends on the accuracy and completeness of the underlying bookkeeping records. The IRS explains that good records help businesses prepare financial statements, monitor progress, track income and expenses, and prepare tax returns.
How Often Should You Prepare an Income Statement?
The right reporting frequency depends on the size, complexity, and needs of your business.
Monthly: Monthly statements help owners monitor performance, identify problems early, and compare actual results with the budget.
Quarterly: Quarterly reports can help evaluate broader trends and support planning throughout the year.
Annually: Annual statements summarize financial performance for the year and may be needed for tax preparation, financing, or other reporting purposes.
For many small businesses, preparing and reviewing an income statement every month is a practical way to maintain financial visibility. Annual reporting remains important, but waiting until the end of the year may make it harder to identify issues early.
Income Statement vs. Balance Sheet vs. Cash Flow Statement
An income statement is one of the main financial statements used to evaluate a business. It works alongside the balance sheet and cash flow statement, but each report serves a different purpose.
Financial Statement
What It Shows
Main Question It Answers
Income statement
Revenue, expenses, and profit or loss over a period
Is the business profitable?
Balance sheet
Assets, liabilities, and equity on a specific date
What does the business own and owe?
Cash flow statement
Cash inflows and outflows over a period
Where is cash coming from and going?
Reviewing all three reports provides a more complete picture of financial performance and position.
A business can report a profit but still experience cash flow problems, for example, if customers have not paid their invoices or significant debt payments are due. That is why profitability and cash flow should be evaluated together.
How to Prepare an Income Statement
Preparing an income statement starts with accurate bookkeeping. The following steps provide a basic framework for a small business.
Gather financial records. Collect sales records, invoices, receipts, bank records, payroll information, and documentation for business expenses.
Choose the reporting period. Decide whether you are preparing a monthly, quarterly, or annual statement.
Calculate revenue. Summarize revenue for the reporting period and account for applicable returns, refunds, or allowances.
Determine direct costs. Calculate the cost of goods sold or other applicable direct costs.
Summarize operating expenses. Group business expenses into clear categories, such as rent, payroll, insurance, marketing, and software.
Include other income and expenses. Record applicable interest, non-operating items, depreciation, and other relevant amounts.
Calculate net income or loss. Subtract the applicable expenses and losses from revenue and gains using the format appropriate for your business.
Review the results. Compare the statement with previous periods and your budget. Investigate unusual changes and confirm that the underlying records are complete.
Accounting software can help organize transactions and generate reports, but the results are only as reliable as the information entered and the bookkeeping procedures used.
Keep Your Business Finances Organized
An income statement is more than a report for a bank or tax professional. It is a practical tool for understanding profitability, managing expenses, setting financial goals, and making better business decisions.
By maintaining accurate bookkeeping records and reviewing your income statement regularly, you can identify trends, address potential problems, and plan for the future with greater confidence.
ContNow Tax Preparation LLC provides online tax preparation and bookkeeping support for individuals and small businesses. If you need help organizing your financial records or preparing income statements for your business, visit contnowtax.com to learn more about our services.
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