The income statement is one of the key financial reports used to understand how much profit or loss a business has made over a period of time. It shows all the money a company earns (revenues) and all the costs it has to pay (expenses).
There are two main ways to present an income statement: the single-step income statement and the multi-step income statement. Each format has its own advantages, and businesses choose the one that best suits their needs.
The single-step income statement is the easiest way to present a company’s financial performance. It simply groups all revenues together in one section and all expenses together in another.
At the end, it calculates the net income using a single formula:
Net Income = Total Revenues - Total Expenses
Example of a Single-Step Income Statement:
Total Revenue: $55,000
Total Expenses: $32,000
Net Income: $23,000
Advantages of the Single-Step Format:
It is simple and easy to read since everything is grouped into just two sections. It is also quick to prepare, making it useful for small businesses that don’t need much detail.
Disadvantages of the Single-Step Format:
It lacks detail because it doesn’t show which parts of the business are making the most money. Additionally, it does not separate operating and non-operating activities, which means important financial insights may be missing.
The multi-step income statement provides a deeper look at a company’s financial performance. Instead of just subtracting expenses from revenue in one step, it divides financial information into sections, making it easier to analyze how the business is making money.
This format separates operating income from the company’s main business activities, non-operating income from investments or other sources, and gross profit, which shows how much money is left after deducting the cost of producing goods or services.
First, it calculates gross profit using the formula:
Gross Profit = Revenue - Cost of Goods Sold
Next, it deducts operating expenses to determine operating income:
Operating Income = Gross Profit - Operating Expenses
Then, it includes non-operating activities, such as investment income, interest expenses, and taxes.
Finally, it calculates the net income, which represents the company's final profit after considering all revenues and expenses.
Example of a Multi-Step Income Statement:
Revenue: $50,000
Cost of Goods Sold (COGS): $20,000
Gross Profit: $30,000
Operating Expenses: $12,000
Operating Income: $18,000
Non-Operating Activities (e.g., investment income, interest, taxes): -$3,000
Net Income: $15,000
Advantages of the Multi-Step Format:
It provides more detailed information, clearly separates costs, and makes financial analysis easier for investors and managers.
Disadvantages of the Multi-Step Format:
It is more complex and requires more effort to prepare. For small businesses, this level of detail may not be necessary.
Small businesses or companies with simple operations may prefer the single-step format because it is quick and easy to read. Larger businesses or companies with different revenue streams should use the multi-step format to get a clearer picture of financial performance.
Both formats are valid, but the choice depends on the level of detail a business needs. Understanding income statements is essential for managing a business effectively, making investment decisions, and ensuring financial success.