At some point you have probably heard the expression “It takes money to make money”. But if you’re not careful, it’s easy to let your spending get out of hand and reach a point where you’re making little or no profit.
That is why all businesses must track their income and expenses with an income statement (P&L). An income statement will help you measure the financial health of your business and see how your business is doing.
Here’s an overview of what an income statement is, what it includes, and how you can use it to get information about your business.
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What is an income statement (P&L)?
An income statement is a financial report that summarizes the income, expenses, and profit or loss of a business during a fiscal year or quarter. When you read an income statement, you will see if the business can generate sales, manage expenses, and make a profit.
The two main categories described in an income statement are income and expenditure. Income includes items such as product sales, interest earned, commissions, or rental income. Expenses include cost of goods sold, marketing and advertising costs, and taxes.
Did you know? Listed companies are required to produce three financial reports each quarter: an income statement, a balance sheet and a cash flow statement.
Why should companies follow the P&L?
If you are not a publicly traded company with shareholders to report to, you might be wondering why it is necessary to create an income statement. But this financial statement gives you the following essential information about your business:
Profitability of your business
An income statement will show whether your business is profitable or not by showing if you are losing money on the sale of your products or services. Keeping track of this information could help you come up with new ideas on how to increase sales.
Overview of your business performance
When you run a business, you want to look at more than your overall income. You also want to observe trends in your business and know if it is growing over time. Tracking industry trends can help you determine specific actions you should take in your business.
For example, if your gross income has been declining since the start of the year, you need to focus on increasing sales. If your gross income is good, but your net income is declining, look for ways to reduce your expenses.
The overall health of your business
At some point, you may need to apply for a small business loan. As part of the approval requirements, your lender will ask you for financial documents like an income statement. This document gives lenders an overview of the overall health of your business and shows them whether it is profitable or not.
Even if you never apply for funding, it’s a good idea to generate an income statement at least once a year. The information you collect will help you make better business decisions. Fortunately, creating an income statement is easier than you might think.
What information do you need for a P&L?
A typical income statement will have four main sections: income, expense, cost of goods sold, and net income. Each section will constitute a new line on the income statement.
The turnover of a business is its net turnover during a given financial period. The section on income will describe the income generated by its main business activities. It will also show non-operating income and income from the sale of business assets.
Your expenses are what you spend on the day to day operations of running your business. This includes things like business insurance, marketing costs, and rent. These expenses are necessary for your business to run smoothly, but do not directly help you generate more income.
Cost of goods sold
This section shows how much it costs your business to produce its products or services. For example, if a business sells physical products, this section might include labor or materials. The cost of goods sold will not include overhead costs such as rent payments.
Here is the formula you will use to calculate the cost of goods sold:
Beginning Inventory + Purchases - Ending Inventory = Cost of Goods Sold
You may notice that although cost of goods sold is technically an expense, it is not included in the expense section. This is because companies separate the cost of goods sold for tax purposes. The IRS says businesses can deduct the cost of goods sold from their taxable income, reducing overall tax obligations.
Your net income is included at the bottom of an income statement. This is what is left after you subtract your expenses from your income.
If your net income shows that you’ve made a profit, your business earns more than it spends. If the business spends more than it earns, you have a net loss for that financial period.
Did you know? Startup statistics show that 40% of small businesses are profitable, 30% break even and 30% continue to lose money.
What is included in an income statement?
Here are some of the information you should include in an income statement:
- Total income
- Total expenses
- Cost of goods sold
- Selling, general and administrative expenses (SG&A)
- Research and development costs
- Marketing and advertising costs
- Interest paid
- Earnings before interest, taxes, depreciation and amortization (EBITDA)
- Net revenue
An income statement includes a variety of information, but some items will not be listed. For example, you don’t include the assets, liabilities, or equity of your business.
Advice: When compiling your income statement, watch out for expense fraud, including people reimbursing expenses or creating fictitious expenses.
Below is a copy of General Motors’ 2018-2020 income statement, which the company calls its consolidated income statement. You will notice that GM posted net income of $ 6.4 billion in 2020, despite the pandemic.
How accounting software can help you manage your income statement
Creating an income statement is not difficult and you can do it yourself. However, the process is much easier if you use accounting software, which will help you stay on top of your small business accounting challenges and avoid common accounting mistakes.
With the right accounting software, you will already be tracking your income and expenses on a regular basis. This means that you can easily generate an income statement at the end of the quarter or year.
If you’re trying to find the right accounting software, here are some of the best options.
QuickBooks is our choice for the best accounting software for small businesses. Read our QuickBooks review for more information. The company offers a wide range of payment tiers, so their software can help you through every step of your business. QuickBooks is a good option for everyone, whether you’re a solo entrepreneur or running a business.
QuickBooks offers many features, including the ability to generate financial reports as an income statement. It will automatically sort your transactions for you and you can track your business cash flow from your dashboard.
FreshBooks is cloud-based accounting and invoicing software that you can access from any device. Read our FreshBooks review for more information. This is a good option for new business owners or people who are new to accounting.
The software uses double-entry accounting, which allows you to easily create financial reports like an income statement and gain insight into the financial health of your business. You can also invite your accountant to collaborate with you on your FreshBooks account.
We chose Xero as the best option for growing businesses because the software offers flexible functionality and a variety of pricing plans. Learn more in our Xero review. It has all the features you need when you are just starting out, as well as advanced features like payroll and inventory management.
You can use Xero to track your spending and understand your cash flow situation in real time. You can also use the software to create financial reports and prepare for tax season.
Wave is free accounting software, and it’s a great option for freelancers and small businesses. Read our Wave review for more information. The software is intuitive and includes all the features you need to track your business finances.
Wave connects to your professional checking account and will automatically track your income and expenses. You can use the dashboard to track unpaid invoices and see your cash balance. The software allows you to easily create and export income statements.
Advice: Check out our reviews of all the best accounting and invoicing software to find the right one for your business.
The bottom line
An income statement gives an overview of how much your business is making and whether you are making or losing money. Businesses of all sizes can benefit from the creation and regular review of an income statement.
If you are new to income statement statements, you may want to create one using a template or consider investing in feature-rich accounting software.
Using software like QuickBooks or Xero will help you track and manage your expenses and generate an income statement in seconds. This way you can stay in control of your finances and be ready for tax season.