What is an income statement?

In the simplest terms, an income statement will show whether your business is making or losing money. It should provide you with enough information to determine whether your company is turning a profit (and how much of a profit), or whether you are operating on a loss (and why). It gives insight into your spending, allowing you to make adjustments before you end up losing too much. It is considered one of the three most essential financial statements, along with cash flow statements (which track inflows and outflows of cash) and balance sheets (which show the financial position of your business at a given time). The key difference between an income statement and these other two documents is that an income statement focuses on profitability, while the other two focus on other elements of your financial health.

The components of an income statement

All income statements contain a few key components.

• Revenue: This is the total amount of money your business has earned from selling products or providing services. This could include sales from both online and brick-and-mortar stores, contract work or even grants and subsidies. Revenue can be broken down into gross revenue (total sales before any deductions) and net revenue (revenue after discounts, returns and allowances have been deducted).
• Cost of goods sold: The direct costs involved in producing the goods or services your business sells. For example, if you own a pizzeria, this would include cheese, meat, flour other ingredients. For a service-based business, it may include labour or materials needed to deliver the service.
• Gross profit: To determine gross profit, subtract cost of goods sold from total revenue. It shows how much your business made after considering the direct costs of producing goods or services but before accounting for other expenses.
• Operating expenses: These are the day-to-day expenses your business incurs that are not directly tied to production, such as rent, utilities, office supplies, marketing and wages. Depending on the nature of your business, this can also include professional fees for accounting, legal services and regulatory compliance.
• Operating income: The profit your business earns after subtracting operating expenses from gross profit. It is the profitability of your core business activities before considering non-operating items like taxes and interest.
• Other income and expenses: This section includes non-operating activities such as interest earned on investments or losses from selling an asset. While these are not directly related to your main business activities, they can still impact your overall profitability.
• Net income: Net income is the final figure after all expenses, taxes and additional income are accounted for. It represents your business’s bottom line (the profit or loss remaining after all deductions have been made).

How to analyze an income statement

To analyze an income statement, you’ll need to understand how all the different components interact and affect overall profitability.

• Trends: Look at multiple income statements over different periods to spot trends, such as whether your revenues are growing or if your costs are increasing. Regular analysis will help you identify patterns that can inform strategic decisions.
• Gross profit margin: This will show what percentage of your revenue is left after accounting for cost of goods sold, with a declining gross profit margin potentially meaning rising production costs or pricing issues.
• Operating margin: This measures your efficiency in managing operational costs. A low or shrinking operating margin might mean that you’re overspending or that your operations are inefficient.
• Net profit margin: This final ratio shows how much profit your business generates for every dollar of revenue after all expenses.
• Expense ratios: You can also assess each expense category as a percentage of revenue. This will help you see where costs are rising and identify potential areas for cost-cutting.

Why income statements are important

Income statements give your business a glance at your financial health, which can help you make informed decisions about whether to grow, cut costs or make other strategic pivots. Income statements are especially important during tax season, since they provide the Canada Revenue Agency with a clear record of revenues and expenses. Many business owners find that working with an accountant or other financial professional to generate income statements can make their lives easier, especially around tax time.

Income statements are also vital for giving lenders, investors and shareholders a sense of your business’ finances. This can help them decide whether or not to invest more money in your company. That’s because they give you a picture of your business’ profitability and will show any risks associated with investing in your company. By regularly generating and reviewing income statements, you’ll make it much easier to track your company’s performance, set viable targets to reach your business goals and develop accurate budgets and forecasts.

Information you need to prepare an accurate income statement

If you want your income statement to be true to your business’ financial circumstances, you’ll need accurate and complete sales records for the period your income statement covers. Gather invoices, receipts, point-of-sale reports and any bank documents. You’ll need detailed records of all direct costs associated with producing goods or delivering services, including raw materials, labour and shipping. Collect information on all day-to-day operational expenses such as rent, utilities, salaries and marketing costs. This includes records of any non-operational income (such as interest) and non-operational expenses (such as depreciation or losses from asset sales). Ensure you have records of any taxes you’ve paid or expect to pay, as well as any tax credits or deductions you’re eligible for. If you have any long-term assets, you’ll need schedules showing their depreciation or amortization over time.

If you’re uncomfortable gathering and preparing all of these elements and generating an income statement yourself, it doesn’t hurt to hire a financial professional such as an accountant or tax preparer. These professionals are used to preparing these documents and presenting them in a way that you’ll understand, at a level of quality that surpasses what the CRA requires. The value of a well-prepared income statement will outweigh the cost of getting a professional to do it.