How to Make a Multi-Step Income Statement

A multi-step income statement provides a detailed view of a company’s financial performance over a specific period, typically a quarter or a year. It segregates revenues and expenses into distinct categories, allowing for a granular analysis of profitability. This structured format helps stakeholders understand how operational and non-operational activities contribute to net income. By breaking down the statement into key subtotals, it offers insights into core business efficiency, cost management, and the impact of other financial activities.

Required Financial Information

To construct a multi-step income statement, gathering specific raw financial data is the initial step. This data originates from a company’s accounting records and typically includes various revenue, cost, and expense accounts. Accurate collection of these figures ensures the resulting statement reflects the true financial picture of the business.

Revenue accounts primarily capture income generated from a company’s main operations. This includes gross sales, the total value of goods or services sold before any reductions. Deductions such as sales returns and allowances, for merchandise returned or price reductions, are also needed. Sales discounts, offered for early payment, further reduce the gross sales figure.

The cost of goods sold (COGS) represents direct costs associated with producing sold goods. This category includes the cost of beginning inventory, which is unsold goods from the previous period. Purchases of new inventory during the current period, along with any freight-in costs, are also required. The value of ending inventory, remaining unsold at period’s close, is then needed.

Operating expense accounts encompass costs incurred in the day-to-day running of a business, separate from COGS. These are broadly categorized into selling expenses and administrative expenses. Selling expenses directly relate to sales and marketing efforts, such as advertising costs and sales salaries. Administrative expenses are general and executive costs not directly tied to sales, including office salaries and rent.

Companies also incur or generate non-operating income and expense, peripheral to main business activities. These items still impact overall profitability. Non-operating income includes interest income earned on investments or dividend income received. Non-operating expenses often involve interest expense on borrowed funds or losses from the sale of assets not used in normal operations.

Income tax expense is a significant deduction accounted for on the income statement. This represents federal and, if applicable, state income taxes owed on a company’s taxable income. It is calculated based on income before taxes, applying prevailing tax rates. This expense is a final deduction before arriving at net income.

Organizing and Categorizing Accounts

After identifying the raw financial information, the next crucial step involves systematically organizing and categorizing these accounts for presentation on a multi-step income statement. This classification process groups similar types of revenues and expenses, preparing them for the structured calculations that will follow. Proper categorization is essential for clearly distinguishing between core operating activities and non-operating financial events.

All sales-related accounts are grouped under sales revenue, including gross sales. Deductions from this amount, such as sales returns and allowances for customer returns or price adjustments, and sales discounts for prompt payment, are then applied. This grouping aims to arrive at a precise net sales figure, reflecting actual revenue from primary business activities.

The cost of goods sold (COGS) section consolidates all direct costs associated with merchandise or services sold. This category includes beginning inventory, the value of goods on hand at the start of the period. Purchases made during the period and any related freight-in costs are added. Ending inventory, representing unsold goods at the period’s close, is then subtracted.

Operating expenses are further divided into selling and administrative sub-categories. Selling expenses are those directly incurred to market, sell, and deliver products or services. Examples include sales salaries paid to the sales force, advertising costs to promote products, and delivery expenses for shipping goods. These expenses are essential for driving revenue.

Administrative expenses encompass general and executive costs required to manage overall business operations. These expenses are not directly linked to sales but are necessary for daily functioning. Common administrative expenses include office salaries for clerical and management staff, rent for the corporate office space, and utility costs. Correctly classifying these expenses helps assess overhead management efficiency.

The category of other income and expenses is for items not part of a company’s primary operating activities. This includes non-operating revenues and expenses. Interest income earned from investments or dividend income received from stock holdings would be classified as other income. Interest expense incurred on borrowed funds or losses arising from the sale of non-operating assets would be categorized as other expenses.

Constructing the Statement Sections

Building a multi-step income statement involves a sequential process, starting with core operational revenues and meticulously deducting various costs and expenses to arrive at the final net income. Each section builds upon the previous one, providing a layered view of profitability. This structured approach helps in understanding the various profit margins a company achieves from its operations and other activities.

The statement begins with the revenue section, specifically detailing the calculation of net sales. This figure is derived by taking gross sales and subtracting any sales returns and allowances, along with sales discounts offered to customers. The formula for this initial step is: Net Sales = Gross Sales – Sales Returns and Allowances – Sales Discounts. This calculation establishes the actual revenue earned from the company’s primary business activities.

Following net sales, the cost of goods sold (COGS) section is presented. This figure represents the direct costs associated with the products sold during the period. It is calculated by taking the beginning inventory for the period, adding the cost of all purchases made during the period (including any freight-in costs), and then subtracting the ending inventory. The formula is: Cost of Goods Sold = Beginning Inventory + Purchases + Freight-in – Ending Inventory.

Once both net sales and cost of goods sold are determined, the gross profit is calculated. Gross profit is a fundamental measure of a company’s profitability from its core business operations, before considering operating expenses. It represents the profit remaining after deducting the direct costs of producing or acquiring the goods sold from the net sales revenue. The calculation is straightforward: Gross Profit = Net Sales – Cost of Goods Sold.

The next major section details operating expenses, categorized into selling and administrative expenses. Selling expenses, such as advertising and sales salaries, are totaled first. Administrative expenses, including office rent and utilities, are separately totaled. These two sub-totals are then added to arrive at the total operating expenses.

After calculating total operating expenses, the operating income is determined. This figure, also known as income from operations, reflects a company’s profitability from its primary business activities, excluding any non-operating items. It is a key indicator of operational efficiency and is calculated by subtracting total operating expenses from gross profit. The formula is: Operating Income = Gross Profit – Total Operating Expenses.

The statement then moves to the other income and expenses section, including revenues and costs not directly related to core operations. This involves interest income, dividend income, or gains from asset sales, which are added to operating income. Interest expense or losses from asset sales are subtracted. The net effect of these items combines with operating income to yield income before taxes.

Income before taxes is the profit figure upon which income tax expense will be calculated. This amount represents all income generated by the company, both operating and non-operating, before any tax deductions. The applicable income tax expense, which includes federal and potentially state income taxes, is then applied to this figure. This tax expense is subtracted from the income before taxes.

Finally, the net income, often referred to as the “bottom line,” is calculated. This is the ultimate measure of a company’s profitability for the accounting period. It represents the amount of profit remaining after all revenues have been recognized and all expenses, including income taxes, have been deducted. The formula for the final step is: Net Income = Income Before Taxes – Income Tax Expense.