An income statement is a necessary financial document for every company. It provides a description (simple or detailed) of business activities during an accounting period. It is a report where a company’s management reports its contribution margin.
It is the financial summary of a business’s revenues, expenses, and profit or loss. It generally includes a balance sheet and cash flow statement.
It is presented in two formats: single-step and multi-step. The use will depend on the structure of the business or the reasons for which the income statement is needed. In addition, there are other types of reports to know the current status of a product or service.
Single-step income statement
The single-step income statement is the financial statement report that shows all expenses, including the cost of goods sold, of a company. It does not divide expenses into categories; they are all listed together and added up.
Its function is to show all accounts. It issues a single subtotal for income items and a single subtotal for expense items. At the bottom, it offers a single net profit or loss.
Many companies use this type of income statement because of its simplicity and speed of preparation. Expenses are not written in detail, but individual expense accounts are combined into broad categories.
The simplicity of the format is one of the reasons why some managements opt for the single-step income statement. However, it does not provide details of the third-party operations of the financial statements.
Although it lacks detail, it is most often used for internal company purposes. It is useful to know the company’s costs by departments and divisions for management to analyze their performance during a certain period.
In some cases, managers use a single-step combination statement for internal use. A combined report includes more detail than a single-step income statement and less information than a multi-step income statement.
How the report is prepared
We already know that the single-step income statement includes a company’s revenues, expenses, and profit or loss for a given period. This being the case, net income is shown in a single formula:
- Net income = (profit + revenue) – (loss + expense).
In that sense, the format is composed of two sections: income and expenses. The first part shows the revenue, which includes income from services and investments and consulting fees.
The second part is the expenses, which are included in sales, administrative, and other interest deductions. A subtotal is reflected in each category.
They are subtracting expenses from income results in income before taxes. Earnings from continuing operations remain the same before taxes, with fewer taxes.
Net income for a period is the same as profit from continuing operations subtracting the after-tax effect of unusual accounts, such as discontinued operations, and proceeds from the disposal of fixed assets and extraordinary performances, including losses.
Small companies such as partnerships, sole proprietorships, and service companies use this type of return, while those selling tangible goods opt for the multi-step format. But sometimes, large companies present the single-step format.
Income statement contribution margin
An income statement is a good ally when highlighting the income and expenses of a business. Every company must prepare an income statement, regardless of the type of business; one option is the income statement contribution margin.
This is a special format where expenses are classified into fixed costs and variable costs. It is used to evaluate the profitability of a product, segment, or service. It also provides a clear view of which costs change with the activity level and which do not.
This type of statement makes it possible to plan different activity levels, as it clearly shows all the fixed costs that the company has to cover. However, it is a report for internal use like the single-step income statement.
It should be noted that the income statement contribution margin shows revenues first, followed by variable costs, including production, administrative and selling expenses, as well as non-operating expenses.
The subtraction between revenues and variable costs reflects the contribution margin. After this result, the fixed expenses continue fixed production, sales, administrative and non-operating expenses. The subtraction between these two elements will give the net income.
Traditional income statement
To know the income and expenses of a company during an accounting period, the traditional income statement or absorption cost income statement is a reliable alternative since it calculates detailed information on financial health.
Unlike the income statements above, this type of report is prepared to show to entities or individuals outside the company. This accounting method makes it possible to capture all fixed costs related to the production of a specific product.
The traditional income statement requires the company to show all overhead costs in one record. This means that the fixed costs associated with production (labor and materials) are in the cost of product inventories.
The formula used to prepare this type of report is:
- Sales – the cost of goods sold = good profit – selling and administrative expenses = net profit.
The traditional income statement can be viewed as a total cost. This is because, when calculating variable costs, fixed costs of production are not included in the cost of producing a product or service.
It turns out that this report takes into account fixed manufacturing costs when calculating the cost of goods manufactured, leaving some to view it as a complete picture of the financial performance of the business.
Budgeted income statement
When a company wishes to measure its performance, it produces a budgeted income statement, nothing more than a financial report comparing estimated income and expense figures with actual figures.
The need for this income statement lies in the measurement of the financial planning process. It is sometimes prepared in conjunction with a budgeted balance sheet to understand which plans are financially more viable.
It is a report that benefits the company and existing and potential investors and lenders who wish to join the organization.
Budget and performance targets are set at the beginning of the accounting period based on past performance and expectations. Departmental and company performance is evaluated.
A good budgeted income statement requires attention to the elements of revenue, expenses, and net income. First, the company should set revenue targets and calculate other input elements: investment earnings or payback.
Then set expense targets, following the same parameters as for revenue. Evaluate three types of expenses separately: operating expenses, material expenses, and non-operating costs. Define an estimated expense figure based on the company’s objectives and situation.
The final single step is to highlight the net profit or loss based on the above revenues and expenses. However, in order to obtain more accurate estimates, it is essential to use best guesses according to unbiased estimates.