How profitable is your business? The only way to really know is to create an income statement.

Here’s how to put one together, how to read one, and why income statements are so important to running your business.

What is an income statement?

• An income statement is a financial statement that shows you how profitable your business was over a given reporting period. It shows your revenue, minus your expenses and losses.
• Also sometimes called a “net income statement” or a “statement of earnings”, the income statement is one of the three most important financial statements in financial accounting, along with the balance sheet and the cash flow statement (or statement of cash flows).
• Small businesses typically start producing income statements when a bank or investor wants to see how profitable their business is.
• When a business makes an income statement for internal use only, they’ll sometimes refer to it as a “profit and loss statement” (or P&L).

Income statement example

Here’s an income statement we’ve created for a hypothetical small business—Coffee Roaster Enterprises Inc., a small hobbyist coffee roastery.

Coffee Roaster Enterprises Inc.

Income Statement

For Year Ended Dec. 31, 2018

Income statements are designed to be read top to bottom, so let’s go through each line, starting from the top.

Sales revenue

• Your company’s revenues are at the top of every income statement.
• This amount will be calculated differently depending on whether you use cash or accrual accounting and how your organization recognizes sales, especially if you’re just measuring revenue for a single month.
• In general, this figure will simply indicate your entire revenue for the time period covered by the income statement. (In this situation, the time period is the calendar year that ends on December 31, 2018.)

Cost of goods sold

• Often shortened to “COGS,” this is how much it cost to produce all of the goods or services you sold to your customers.
• COGS only involves direct expenses like raw materials, labor and shipping costs. If you roast and sell coffee like Coffee Roaster Enterprises, for example, this might include the cost of raw coffee beans, wages, and packaging.
• Indirect expenses like utilities, bank fees, and rent are not included in COGS—we put those in a separate category.

Gross profit

• This is what you get when you subtract total COGS from revenue. Gross profit tells you how profitable your business is after taking into account direct costs, but before taking into account overhead costs. It’s a rough measure of how efficient your business is.

General expenses

• Also sometimes referred to as “operating expenses,” these include rent, bank & ATM fee expenses, equipment expenses, marketing & advertising expenses, merchant fees, and any other expenses you need to make to keep your business going.
• These expenses are listed individually here, but some income statements will bundle these and other similar expenses together into one broad category called “Selling, General & Administrative Expenses” (SG&A).

Operating earnings

• This is how profitable your business is after taking into account all internal costs, which you have more control over, but before taking into account external costs like loan interest payments and taxes, which you have less control over.
• Accountants will sometimes call this Operating Profit or Operating Income.

Interest expense

• If your business owes someone money, it probably has to make monthly interest payments. Your interest expenses are the total interest payments your business made to its creditors for the period covered by the income statement.

Earnings before income tax

• This is your business’s profitability before it pays its taxes.

Income tax expense

• This is how much you paid Uncle Sam.

Net profit

• Ever wonder where we get the expression “bottom line” from? This is it! This is the final, total profit for your business.

Income statement vs. balance sheet: what’s the difference?

A balance sheet displays how much money you have (assets), how much money you owe (liabilities), and how much money you have leftover (equity). It’s a snapshot of your whole business at a certain point in time.

An income statement explains how lucrative your company is. It displays the amount of money that has come into and out of your firm during a specific time period.