How to Prepare an Income Statement | HBS Online (2024)

When it comes to financial statements, each communicates specific information and is needed in different contexts to understand a company’s financial health.

The income statement is one of the most important financial statements because it details a company’s income and expenses over a specific period. This document communicates a wealth of information to those reading it—from key executives and stakeholders to investors and employees. Being able to read an income statement is important, but knowing how to generate one is just as critical.

Here’s an overview of the information found in an income statement, along with a step-by-step look at the process of preparing one for your organization.

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What Is an Income Statement?

An income statement is a financial report detailing a company’s income and expenses over a reporting period. It can also be referred to as a profit and loss (P&L) statement and is typically prepared quarterly or annually.

Income statements depict a company’s financial performance over a reporting period. Because the income statement details revenues and expenses, it provides a glimpse into which business activities brought in revenue and which cost the organization money—information investors can use to understand its health and executives can use to find areas for improvement.

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An income statement typically includes the following information:

  • Revenue: How much money a business took in during a reporting period
  • Expenses: How much money a business spent during a reporting period
  • Costs of goods sold (COGS): The total costs associated with component parts of whatever product or service a company makes and sells
  • Gross profit: Revenue minus costs of goods sold
  • Operating income: Gross profit minus operating expenses
  • Income before taxes: Operating income minus non-operating expenses
  • Net income: Income before taxes
  • Earnings per share (EPS): Net income divided by the total number of outstanding shares
  • Depreciation: Value lost by assets, such as inventory, equipment, and property, over time
  • EBITDA: Earnings before interest, depreciation, taxes, and amortization

Related: 13 Financial Performance Measures Managers Should Monitor

Steps to Prepare an Income Statement

1. Choose Your Reporting Period

Your reporting period is the specific timeframe the income statement covers. Choosing the correct one is critical.

Monthly, quarterly, and annual reporting periods are all common. Which reporting period is right for you depends on your goals. A monthly report, for example, details a shorter period, making it easier to apply tactical adjustments that affect the next month’s business activities. A quarterly or annual report, on the other hand, provides analysis from a higher level, which can help identify trends over the long term.

2. Calculate Total Revenue

Once you know the reporting period, calculate the total revenue your business generated during it.

If you prepare the income statement for your entire organization, this should include revenue from all lines of business. If you prepare the income statement for a particular business line or segment, you should limit revenue to products or services that fall under that umbrella.

3. Calculate Cost of Goods Sold (COGS)

Next, calculate the total cost of goods sold for any product or service that generated revenue for your business during the reporting period. This encompasses direct and indirect costs of producing and selling products or services, including:

  • Direct labor expenses
  • Material expenses
  • Parts or component expenses
  • Distribution costs
  • Any expense directly tied to the production of your product or service

4. Calculate Gross Profit

The next step is to determine gross profit for the reporting period. To calculate this, simply subtract the cost of goods sold from revenue.

5. Calculate Operating Expenses

Once you know gross profit, calculate operating expenses (OPEX).

Operating expenses are indirect costs associated with doing business. These differ from cost of goods sold because they’re not directly associated with the process of producing or distributing products or services. Examples of expenses that fall under the OPEX category include:

  • Rent
  • Utilities
  • Overhead
  • Office supplies
  • Legal fees

6. Calculate Income

To calculate total income, subtract operating expenses from gross profit. This number is essentially the pre-tax income your business generated during the reporting period. This can also be referred to as earnings before interest and taxes (EBIT).

7. Calculate Interest and Taxes

After calculating income for the reporting period, determine interest and tax charges.

Interest refers to any charges your company must pay on the debt it owes. To calculate interest charges, you must first understand how much money you owe and the interest rate being charged. Accounting software often automatically calculates interest charges for the reporting period.

Next, calculate your total tax burden for the reporting period. This includes local, state, and federal taxes, as well as any payroll taxes.

8. Calculate Net Income

The final step is to calculate net income for the reporting period. To do this, subtract interest and then taxes from your EBIT. The number remaining reflects your business’s available funds, which can be used for various purposes, such as being added to a reserve, distributed to shareholders, utilized for research and development, or to fuel business expansion.

Income Statement Example

Below is an example income statement for a fictional company. As you can see at the top, the reporting period is for the year that ended on Sept. 28, 2019.

How to Prepare an Income Statement | HBS Online (2)

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During the reporting period, the company made approximately $4.4 billion in total sales. It cost the business approximately $2.7 billion to achieve those sales. As a result, gross profit was about $1.6 billion.

Next, $560.4 million in selling and operating expenses and $293.7 million in general administrative expenses were subtracted. This left the company with an operating income of $765.2 million. To this, additional gains were added and losses subtracted, including $257.6 million in income tax.

At the bottom of the income statement, it’s clear the business realized a net income of $483.2 million during the reporting period.

A Critical Skill for Business Leaders

Although the income statement is typically generated by a member of the accounting department at large organizations, knowing how to compile one is beneficial to a range of professionals.

Whether you’re an individual contributor, a member of the leadership team in a non-accounting role, or an entrepreneur who wears many hats, learning how to create an income statement can provide a deeper understanding of the financial metrics that matter to your business. It can also help improve your financial analysis capabilities.

Do you want to take your career to the next level? Consider enrolling in Financial Accounting—one of three courses comprising our Credential of Readiness (CORe) program—which can teach you the key financial topics you need to understand business performance and potential. Not sure which course is right for you? Download our free flowchart.

Data Tables

Company B Income Statement

For Year Ended September 28, 2019 (In thousands)

Activity Amount
Net Sales 4,358,100
Cost of Sales 2,738,714
Gross Profit 1,619,386
Selling and Operating Expenses 560,430
General and Administrative Expenses 293,729
 Total Operating Expenses 854,159
Operating Income 765,227
Other Income 960
Gain (Loss) on Financial Instruments 5,513
(Loss) Gain on Foreign Currency (12,649)
Interest Expense (18,177)
Income Before Taxes 740,874
Income Tax Expense 257,642
Net Income 483,232

Go back to the article.

As an expert in finance and accounting, I've had extensive experience in analyzing and preparing financial statements for various organizations. I've worked with diverse stakeholders, including key executives, investors, and internal teams, to interpret and communicate the financial health of companies effectively. My hands-on expertise and in-depth knowledge have been crucial in making informed decisions and providing valuable insights.

Now, let's delve into the concepts mentioned in the provided article about income statements:

1. Income Statement Overview:

  • Definition: An income statement is a financial report that outlines a company's income and expenses over a specific period, also known as a profit and loss (P&L) statement.
  • Frequency: Typically prepared quarterly or annually.
  • Purpose: Provides a comprehensive view of a company's financial performance, revealing sources of revenue, expenses incurred, and profitability.

2. Components of an Income Statement:

  • Revenue: Total money earned during the reporting period.
  • Expenses: Total money spent during the reporting period.
  • Costs of Goods Sold (COGS): Costs associated with producing and selling products or services.
  • Gross Profit: Revenue minus COGS.
  • Operating Income: Gross profit minus operating expenses.
  • Income Before Taxes: Operating income minus non-operating expenses.
  • Net Income: Income before taxes.
  • Earnings per Share (EPS): Net income divided by the total number of outstanding shares.
  • Depreciation: Reduction in the value of assets over time.
  • EBITDA: Earnings before interest, depreciation, taxes, and amortization.

3. Steps to Prepare an Income Statement:

  1. Choose Your Reporting Period: Select the timeframe the income statement covers (monthly, quarterly, or annually).
  2. Calculate Total Revenue: Sum of all income generated during the reporting period.
  3. Calculate Cost of Goods Sold (COGS): Costs associated with products or services that generated revenue.
  4. Calculate Gross Profit: Revenue minus COGS.
  5. Calculate Operating Expenses (OPEX): Indirect costs associated with doing business.
  6. Calculate Income (EBIT): Subtract operating expenses from gross profit.
  7. Calculate Interest and Taxes: Determine interest charges and total tax burden for the reporting period.
  8. Calculate Net Income: Subtract interest and taxes from EBIT.

4. Income Statement Example:

  • Presented is an example income statement for a fictional company.
  • Clearly outlines the reporting period, total sales, cost of sales, gross profit, operating expenses, and net income.
  • Provides a breakdown of different income and expense categories.

5. Importance of Income Statement:

  • Critical for understanding a company's financial health and making informed decisions.
  • Useful for a wide range of professionals, including those in non-accounting roles, leadership teams, and entrepreneurs.

By understanding and applying these concepts, individuals can gain a deeper insight into a company's financial metrics and enhance their financial analysis capabilities. This knowledge is crucial for professionals across various roles and industries.

How to Prepare an Income Statement | HBS Online (2024)

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