How to Prepare an Income Statement Step-by-Step

An income statement summarizes a company’s financial performance over a specific period, such as a quarter or a year. It details how a company’s revenue transforms into net earnings, also known as profit or loss. This financial statement helps business owners, investors, and creditors assess profitability and overall financial health. Unlike a balance sheet, which offers a snapshot at a single point in time, an income statement showcases performance across a duration, offering insights into operational efficiency.

Identifying Essential Financial Information

Preparing an income statement begins with gathering specific financial data reflecting a business’s operations. This includes all income generated from core business activities, known as revenue, which stems from the sale of goods or services before any expenses are deducted. Revenue sets the foundation for understanding a company’s earning capacity and is often considered the “top line” of the income statement.

The cost of goods sold (COGS) represents the direct costs tied to producing the goods or services a company sells. For a merchandising business, COGS includes the purchase price and freight-in costs of items sold, while for a manufacturing business, it covers the cost of producing the sold products. Businesses must account for these direct expenses to accurately determine profitability from their primary offerings.

Operating expenses encompass the costs incurred in running day-to-day activities, not directly related to production. These often include selling, general, and administrative (SG&A) expenses, such as salaries for administrative personnel, office rent, utilities, marketing, and depreciation. These expenses are subtracted from gross profit to determine operating income, reflecting how efficiently a company generates profit from its main operations.

Non-operating income and expenses arise from activities not directly linked to the main business. Examples include interest income from investments, interest expense on loans, or gains and losses from selling assets. These items are accounted for separately because they do not reflect the company’s primary business performance. Income tax expense, calculated based on the company’s earnings before taxes, is also a required piece of information for the income statement.

Understanding the Income Statement Structure

The income statement follows a structured format, presenting financial information in a logical sequence to reveal a company’s profitability at different stages. It begins with total revenue, which represents the overall earnings from sales or services during the specified period.

From the total revenue, the cost of goods sold (COGS) is subtracted, leading to the calculation of gross profit. Gross profit indicates the profit a company makes after covering the direct costs associated with producing or acquiring the goods sold. This subtotal offers a preliminary view of profitability before considering broader operational costs.

Next, operating expenses, such as selling, general, and administrative costs, are deducted from gross profit to arrive at operating income. Operating income, also known as Earnings Before Interest and Taxes (EBIT), shows the profit generated purely from a company’s core business operations, excluding financing costs and taxes. This metric is valuable for assessing operational efficiency.

Following operating income, non-operating income and expenses are factored in, which includes items like interest income, interest expense, and gains or losses from asset sales. Adding non-operating income and subtracting non-operating expenses yields earnings before taxes (EBT). This figure represents all income and expenses, both operating and non-operating, before the impact of income taxes.

The final step in the structure involves subtracting income tax expense from earnings before taxes to arrive at net income. Net income, often referred to as the “bottom line,” is the ultimate profit or loss a company has achieved after all revenues and expenses, including taxes, have been accounted for.

Step-by-Step Income Statement Assembly

Assembling an income statement involves systematically calculating and subtracting various financial figures for a specific accounting period. The first step requires calculating total revenue by summing all sales of goods or services rendered during the period. For instance, if a business sells products totaling $100,000 and provides services worth $50,000 in a quarter, the total revenue would be $150,000.

Following the determination of total revenue, the cost of goods sold (COGS) must be calculated. For businesses that sell products, this often involves the formula: beginning inventory plus purchases, minus ending inventory. For a service business, COGS would include direct costs like labor and materials directly tied to delivering the service.

Once COGS is determined, it is subtracted from total revenue to calculate gross profit. If total revenue was $150,000 and COGS was $60,000, the gross profit would be $90,000.

The next step involves summing all operating expenses incurred during the period. This category includes costs such as salaries, rent, utilities, marketing, and depreciation, which are necessary for the general running of the business but are not directly related to producing goods or services. If these expenses total $30,000, they are then subtracted from the gross profit.

Subtracting total operating expenses from gross profit yields operating income. Continuing the example, if gross profit is $90,000 and operating expenses are $30,000, the operating income is $60,000.

After calculating operating income, any non-operating income is added, and non-operating expenses are subtracted. For example, if a company earned $1,000 in interest income and incurred $500 in interest expense, these amounts would adjust the operating income. This step leads to the earnings before taxes (EBT).

The calculation of income tax expense is based on the EBT. For corporations in the United States, the federal corporate income tax rate is a flat 21% as of 2025. State and local corporate income taxes also apply, varying by jurisdiction, and are generally deductible for federal income tax purposes.

Finally, the calculated income tax expense is subtracted from the earnings before taxes to arrive at net income. This final figure represents the company’s total profit or loss for the accounting period after all revenues have been collected and all expenses, including taxes, have been paid.