Are you here to learn how to prepare an income statement without any hassle? Then here, after reading this article, you will definitely do it easily. In this article, I will enlist easy steps and will provide step by step guide on how to prepare an income statement from available data. Let’s first explore it with me.
What is an Income Statement?
The income statement mainly focuses on the revenue, expenses, gains, and losses of a company during a specific time period. Its main focus is to shows the financial position of a company over a specific time period. Moreover, as compared to balance sheet and cash flow statement, an income statement is one of the most important financial statement that depicts a company’s true financial performance over a specific period of time. It is also known as profit and loss statement.
An income statement is a financial report that lists and describes a company’s earnings and outlays over a reporting period and displays the company’s financial position at the time the statement is made.
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Income Statement Formula
Gross profit = Net sales – COGS
Operating income/ EBIT = Gross – Operating expenses
Net income = EBIT – (interest expense + Tax expense)
Moving further toward our main topic, you first must understand following terms of income statement. As you know, an income statement is all about earnings and losses, so here are some important terms with its definition and formulas to better guide.
Net sales are the income that a company earned by selling its final goods and services.
Sales – Sales return & allowance – Sales discounts – Transportation Out
It depict the total cost after deducting purchase discount and return.
Purchases – Purchase return – Purchase discounts + Transportation In
Cost of Goods Sold
COGS include all the cost associated to make the product.
Opening Inventory + Purchases – Ending Inventory
Profit earned the by deducting main/ direct cost.
Net Sales – COGS
Reduce operating expenses from gross profit.
Gross profit – Operating Expenses
Include other income you received from other sources.
Operating income + Other Income
Less interest income from EBIT
EBIT – Interest Expense
Finally you got the income after reducing all expenses.
EBT – Tax Expense
Income Statement Format
According to the format, there are three main sections: Gross Margin section, Operating expense section, and the non-operating expense section. Each section contains some steps.
Steps of Preparing an Income Statement
Preparing an income statement requires 8 steps to follow.
- 1st Step: Calculate Net Sales
- 2nd step: Calculate Cost of Goods Sold
- 3rd Step: Calculate Gross Profit
- 4th Step: Calculate Operating Expenses
- 5th Step: Calculate Operating Income
- 6th Step: Calculate the Net Income before Interest & Taxes (EBIT)
- 7th Step: Calculate EBT
- 8th Step: Calculate Net Income
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Now let’s discuss each step in detail.
STEP 1: CALCULATE NET SALES
The first step is to calculate the net sales. Net sales is the total earning a company receive after reducing all sales related expenses. You can calculate it by simply following these steps:
Cash sales xxx
Add: Credit sales xxx
Total sales xxx
Less: Sales discount (xxx)
Less: Sales return & allowance (xxx)
Less: Transpiration-Out (xxx)
Net Sales xxxx
To make the process more easy, there are number of online accounting software available that are offering number of built-in functions such as income statement, balance sheet, and cash flow statement templates.
STEP 2: CALCULATE COST OF GOODS SOLD
The next step is the calculation of the COGS (Cost of Goods Sold). COGS is the direct cost that incurred to make a product. In order to calculate it, first take the beginning inventory then add total purchases in it and then less the ending inventory of the company. You should follow the below listed COGS (Cost of Goods Sold) Format.
Opening Inventory xxx
Less: Purchase discount (xxx)
Less: Purchase returns & allowances (xxx)
Add: Transpiration-In xxx
Total Purchases xxx
Goods available for sale xxx
Less: Ending Inventory (xxx)
Cost of Goods Sold xxxx
STEP 3: CALCULATE GROSS PROFIT
3rd step requires you to calculate Gross Profit. You can easily find it by subtracting the cost of goods from net sales.
Net Sales xxx
Less: Cost of Goods Sold (xxx)
Gross Profit xxx
STEP 4: CALCULATE OPERATING EXPENSES
In this step, calculate all the operating expenses of your company such as rent expenses, depreciation, maintenance charges, salaries expenses, and other expenses incurred during the period. Unlike COGS, operating expenses are indirect cost hat are required to complete the administrative and selling process.
STEP 5: CALCULATE OPERATING INCOME
It’s very simple step, here you will calculate your operating income as follows:
Gross Profit xxx
Less: Operating Expenses (xxx)
Operating Income xxx
STEP 6: CALCULATE THE NET INCOME BEFORE INTEREST & TAXES (EBIT)
In this step, you will add your other non-operating income: income you receive from other sources such as investment in stock or properties.
STEP 7: CALCULATE EBT
EBT is the earning before tax. To calculate it, just less interest expense from the EBIT.
Earnings before Interest & Tax xxx
Less: Interest Expense (xxx)
Earning before Tax xxxx
STEP 8: CALCULATE NET INCOME
This is the last step in which you can easily find the net income by subtracting all the taxes of company from its income (EBT). Here, you will get your final net income you actually earned.
Earning before Tax xxx
Less: Tax Expense (xxx)
Net Income xxxx
Income Statement Example
Let’s move toward the practical example of how to prepare an income statement.
Below is the portion of adjusted trail balance of the Inshirah Company. On March 1st, the company possess merchandise inventory of $5,000.
Trial balance as on March 31st, XXXX
Sales return & allowance
For The Year Ending March 31st, XXXX
Less: Sales discounts
Sales return and allowances
Less: Cost of goods sold
Less: Purchase discount
Goods available for sale
Less: Ending inventor, Dec 31
Cost of goods sold
EBIT (Earnings before interest & tax)
Less: Interest expenses
Income before tax
Less: Income tax expense
Here, you can see that company’s net income for the period ended March 32st is $14,900. It depicts that after paying all expenses, Inshirah Company actually earn $14,900. In order to analyze company’s actual performance, you can use vertical and horizontal analysis and well as ratio analysis. Vertical and horizontal analysis will depicts company’s current performance compared to its previous year’s performance. Moreover, ratio analysis will help to identify company’s performance over its competitors.
- An income statement depicts a company’s financial performance by listing all of its expenses as well as how much money it has earned during the reporting period.
- It is a most important financial statement among all three statements.
- An income statement can be prepared on monthly, quarterly, and annually basis.
Hira Aziz - Author
She is a Business Content writer and Management contributor at 12Manage.com, where she contributes a business article weekly. She has over 2 years of experience in writing about accounting, finance, and business.
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