Income statement (profit and loss statement)

An income statement, also called a profit and loss statement or P&L, shows how much revenue a business earned over a period and what it cost to earn it. It covers a span of time, such as a month, a quarter or a year, and ends with net income: the profit or loss left after every expense, interest and income tax.

What goes on an income statement

• Revenue: sales of products and services. The top line is gross revenue; subtracting returns, allowances and discounts gives net revenue.
• Cost of goods sold: the direct cost of what was sold, such as materials, freight in and production labour.
• Gross profit: net revenue minus the cost of goods sold.
• Operating expenses: costs that keep the business running but can't be tied to a specific sale, such as rent, office salaries, software and marketing. Many statements group these as selling, general and administrative expenses (SG&A).
• Operating income: gross profit minus operating expenses.
• Other income and expenses: interest paid or earned and one-off gains or losses.
• Income tax and net income: the bottom line.

How to make an income statement

1. Pick the period. A month for management, a year for tax and lenders.
2. Close the books for that period. Record every sale, bill, receipt and card charge, reconcile the bank and card accounts, and run a trial balance.
3. Total revenue from the income accounts, then subtract returns and discounts.
4. Total the cost of goods sold and subtract it to get gross profit.
5. Total operating expenses by category and subtract them to get operating income.
6. Add other income, subtract interest and other expenses, then income tax, to reach net income.
7. Compare it with the previous period or the budget. A single statement says little; the change from one period to the next is what shows a problem.

Accounting software produces the statement from the general ledger in one click. The work is in step 2: the report is only as good as the transactions behind it.

Income statement vs balance sheet

The income statement covers a period and shows performance. The balance sheet is a snapshot on one date and shows what the business owns and owes. Net income from the income statement flows into retained earnings on the balance sheet, which is how the two connect.

On a tax return

Sole proprietors file a version of the income statement with their return: Schedule C in the US and form T2125, the Statement of Business or Professional Activities, in Canada. Both start from gross receipts or sales and subtract the cost of goods sold and business expenses.

Where the numbers come from

Most errors on a small business income statement are coding errors: a supplier receipt booked to the wrong expense account, a card charge with no receipt left in an uncategorized account, sales tax recorded as an expense. Smartbills reads each receipt and bill, suggests the expense account and splits the sales tax before it syncs to QuickBooks, Xero, Sage or FreshBooks, where the income statement is produced.