How To Prepare An Income Statement?

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.

how to prepare an income statement
Definition

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)

Key Terms

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.

Item

Definition

Formula

Net Sales

Net sales are the income that a company earned by selling its final goods and services.

Sales – Sales return & allowance – Sales discounts – Transportation Out

Total Purchases

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 

Gross profit

Profit earned the by deducting main/ direct cost.

Net Sales – COGS

Operating Income

Reduce operating expenses from gross profit.

Gross profit – Operating Expenses

EBIT

Include other income you received from other sources.

Operating income + Other Income

EBT

Less interest income from EBIT

EBIT – Interest Expense

Net Income

Finally you got the income after reducing all expenses.

EBT – Tax Expense

Income Statement Format

prepare an Income statement by using easy income statement step by step 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

        Purchases                    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.

                                 Inshirah Company

                Trial balance as on March 31st, XXXX

 

   Debit

Credit

Sales

 

$100,000

Sales return & allowance

$1000

 

Sales discount

500

 

Purchases

70,000

 

Insurance charges

6,000

 

Purchase discount

 

600

Freight In 

400

 

Depreciation expense

2,000

 

Salaries Expense 

6,000

 

Merchandise Inventory

20,000

 

Building maintenance

5,000

 

Adverting expenses

1,000

 

Interest Expense

1,000

 

Tax expense

7,500

 

                                                 Inshirah Company

                                              INCOME STATEMENT

                               For The Year Ending March 31st, XXXX

          Sales

 

$100,000

Less: Sales discounts

  $1000

 

         Sales return and allowances

     800

 
  

(1,800)

          Net sales

 

98,200

Less: Cost of goods sold

  

Beginning inventory

 5,000

 

Add: Purchases

70,000

 

         Freight-in

     400

 
 

75,400

 

Less: Purchase discount

   (600)

 

        Goods available for sale

74,800

 

Less: Ending inventor, Dec 31

(20,000)

 

          Cost of goods sold

 

(54,800)

          Gross profit

 

43,400

Operating expenses

 

 

       Adverting expenses

 1,000

 

       Depreciation expenses

 2,000

 

       Building maintenance

 5,000

 

         Salaries expense

 6,000

 

         Insurance Charge

6,000

(20,000)

EBIT (Earnings before interest & tax)

 

23,400

Less: Interest expenses

 

(1,000)

Income before tax

 

22,400

Less: Income tax expense

 

(7,500)

          Net income

 

14,900

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.

Key Points

  • 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.

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Hira Aziz

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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