What is an income statement?

Published Thursday 23 July 2026

Table of contents

• What is an income statement?
• Why income statements matter for small businesses
• Key components of an income statement
• How to prepare an income statement
• Single-step vs. multi-step income statement
• Income statement vs. balance sheet vs. cash flow statement
• Income statement example
• How to read and analyze an income statement
• Simplify your income statements with Xero
• FAQs on income statements

Key takeaways

• An income statement, also called a profit and loss (P&L) statement, summarizes your revenue, expenses, and net income over a specific period so you can see whether your business is profitable.
• The 5 core components of an income statement are revenue, cost of goods sold (COGS), gross profit, operating expenses, and net income or net loss.
• Preparing an income statement regularly helps you make informed financial decisions, qualify for loans, and stay ready for tax season.
• Accounting software like Xero can generate income statements automatically, saving you time and reducing the risk of manual errors.

What is an income statement?

An income statement is a financial report that shows your business's revenue, expenses, and profit or loss over a specific time period. It's also known as a profit and loss statement (P&L statement), a statement of earnings, or a statement of operations.

Unlike a balance sheet, which captures a snapshot of your finances at a single point in time, an income statement covers a defined reporting period. That period could be a month, a quarter, or a full fiscal year.

The purpose of an income statement is straightforward: it tells you whether your business made money or lost money during that period. By listing all your revenue sources and subtracting all your expenses, you arrive at a bottom line figure called net income (or net loss).

Why income statements matter for small businesses

Income statements give you a clear picture of your business's financial performance so you can plan ahead with confidence. Whether you're deciding where to cut costs, applying for funding, or preparing your tax return, this report is one of the most useful tools you have.

Making informed financial decisions

An income statement shows you exactly where your money is coming from and where it's going. When you can see which products or services generate the most revenue and which expenses are eating into your profits, you can make smarter spending decisions.

For example, if your operating expenses have climbed steadily over 3 consecutive quarters, your income statement makes that trend visible. You can then decide whether to renegotiate supplier contracts, reduce overhead, or invest more in the areas driving growth.

Applying for loans and credit

Lenders and investors typically ask for income statements as part of any funding application. A well-prepared P&L shows that your business generates consistent revenue and manages expenses responsibly.

If you're applying for a small business loan or line of credit, having up-to-date income statements ready can speed up the approval process. It signals to lenders that you understand your financial position and track it regularly.

Staying tax-ready and compliant

Your income statement provides a clear summary of the financial data you need for tax reporting. It captures your total revenue and deductible expenses in 1 place, which makes filing your return with the Internal Revenue Service (IRS) much simpler.

Reviewing your income statement throughout the year also helps you estimate quarterly tax payments more accurately. This way, you avoid surprises at tax time and reduce the risk of underpayment penalties.

Key components of an income statement

An income statement is built from 5 core line items that flow from top to bottom, starting with your total revenue and ending with your net income. Here's what each component means for your business.

Revenue

Revenue is the total amount of money your business earns from selling goods or services before any expenses are subtracted. It's sometimes called the "top line" because it appears at the very top of the income statement.

Revenue can include sales income, service fees, subscription payments, and any other earnings from your core business activities. It does not include loans, investments, or other non-operating income.

Cost of goods sold (COGS)

Cost of goods sold (COGS) represents the direct costs tied to producing or delivering the products and services you sell. For a retail business, COGS includes the purchase price of inventory. For a service business, it might include labor costs directly tied to delivering that service.

COGS does not include indirect costs like rent, marketing, or administrative salaries. Those fall under operating expenses instead.

Gross profit

Gross profit is the amount left after you subtract COGS from your total revenue. It tells you how much money your business retains from sales before accounting for overhead and other operating costs.

The formula is simple: gross profit = revenue - COGS. A healthy gross profit means your pricing and production costs are in a good balance. You can learn more about tracking and improving this figure in the guide to measuring profitability. If your gross profit is shrinking over time, it could signal that your costs are rising faster than your prices.

Operating expenses

Operating expenses are the ongoing costs of running your business that aren't directly tied to producing your product or service. Common examples include rent, utilities, insurance, marketing, office supplies, and employee salaries.

These expenses are sometimes grouped into categories like selling, general, and administrative expenses (SG&A). Keeping a close eye on operating expenses helps you spot opportunities to reduce overhead without affecting the quality of your products or services.

Net income (or net loss)

Net income is the final figure at the bottom of your income statement, which is why it's often called the "bottom line." You calculate it by subtracting all expenses, including COGS, operating expenses, interest, and taxes, from your total revenue.

If the result is positive, your business made a net profit during that period. If it's negative, you operated at a net loss. Tracking net income over multiple periods helps you identify whether your business is trending toward profitability or moving in the wrong direction.

How to prepare an income statement

Preparing an income statement involves gathering your financial data and organizing it into a structured format. Follow these 4 steps to create one for your business.

Step 1. Choose your reporting period

Decide the time frame your income statement will cover. Most small businesses prepare income statements monthly, quarterly, or annually.

Monthly statements give you the most frequent visibility into your financial performance. Quarterly and annual statements are useful for spotting longer-term trends and are typically required for tax filing and loan applications.

Step 2. Gather your financial data

Collect all your revenue and expense records for the reporting period you chose. This includes sales receipts, invoices, bank statements, payroll records, and any other transaction data.

If you use accounting software, most of this data is already recorded and categorized for you. Pulling it together manually from spreadsheets or paper records takes significantly more time and increases the chance of errors.

Step 3. Calculate revenue, expenses, and net income

Start by adding up all your revenue for the period. Then calculate your COGS and subtract it from revenue to get your gross profit. Next, add up all your operating expenses and subtract them from gross profit.

Finally, subtract any additional costs like interest and taxes to arrive at your net income. The formula looks like this: net income = revenue - COGS - operating expenses - interest - taxes.

Step 4. Review and verify accuracy

Check your income statement for errors before using it to make decisions. Compare the figures against your bank statements, receipts, and other source documents to make sure everything matches.

Look for any transactions that may have been missed, duplicated, or categorized incorrectly. If you work with an accountant or bookkeeper, have them review the statement as an additional layer of verification.

Single-step vs. multi-step income statement

There are 2 main formats for an income statement, and each one suits different business needs. The format you choose depends on how much detail you need in your financial reporting.

A single-step income statement groups all your revenue together and all your expenses together, then subtracts total expenses from total revenue in 1 calculation. It's the simpler format and works well for sole proprietors, freelancers, and small businesses with straightforward finances.

A multi-step income statement breaks the calculation into several stages. It separates operating revenue from non-operating revenue and calculates intermediate figures like gross profit and operating income before arriving at net income. This format gives you a more detailed view of where your profits and losses are coming from.

If you need to analyze the profitability of your core operations separately from other income sources (like interest or one-time gains), a multi-step format is the better choice. For day-to-day tracking and simpler reporting needs, a single-step statement is usually sufficient.

Income statement vs. balance sheet vs. cash flow statement

The income statement is 1 of 3 core financial statements that together give you a complete picture of your business's financial health. Each report serves a different purpose.

An income statement shows your revenue, expenses, and profit or loss over a specific period. It answers the question: "Did my business make money during this time frame?"

A balance sheet shows what your business owns (assets), what it owes (liabilities), and the owner's equity at a single point in time. It answers the question: "What is my business worth right now?"

A cash flow statement tracks the actual movement of cash in and out of your business over a period. It answers the question: "Where did my cash come from and where did it go?"

Together, these 3 financial statements provide a comprehensive view. Your income statement may show a profit, but your cash flow statement might reveal that most of that revenue hasn't been collected yet. Reviewing all 3 side by side helps you understand both profitability and liquidity.

Income statement example

Here's a simple income statement example for a fictional small business, Sunny Side Bakery, covering the month of January 2026. This follows the single-step format.

Revenue

• Bakery sales: $28,000
• Catering income: $4,500
• Total revenue: $32,500

Cost of goods sold (COGS)

• Ingredients and raw materials: $9,800
• Packaging: $1,200
• Total COGS: $11,000

Gross profit: $21,500

Operating expenses

• Rent: $3,000
• Employee wages: $8,500
• Utilities: $600
• Marketing: $750
• Insurance: $400
• Total operating expenses: $13,250

Net income: $8,250

In this example, Sunny Side Bakery earned $32,500 in total revenue during January. After subtracting $11,000 in direct costs and $13,250 in operating expenses, the bakery ended the month with a net income of $8,250. That positive bottom line means the business was profitable for the period.

How to read and analyze an income statement

Reading an income statement means going beyond the bottom line to understand what's driving your profits or losses. A few key techniques can help you get more value from this report.

Calculate your profit margins. Your gross profit margin (gross profit divided by revenue) shows how efficiently you produce your goods or services. Your net profit margin (net income divided by revenue) shows how much of every dollar in revenue you actually keep. For example, if your revenue is $32,500 and your net income is $8,250, your net profit margin is about 25%.

Compare across periods. Looking at income statements from multiple months or quarters side by side reveals trends. Steadily rising revenue paired with stable expenses is a strong sign. Rising expenses that outpace revenue growth may signal a problem worth investigating.

Benchmark against your industry. Comparing your profit margins and expense ratios to industry averages helps you understand how your business stacks up. If your COGS is significantly higher than the industry norm, it might be time to explore different suppliers or adjust your pricing.

Watch for red flags. Look for sudden spikes in specific expense categories, declining gross profit margins, or a widening gap between revenue and net income. These patterns can point to issues like rising supplier costs, underpricing, or inefficiencies in your operations.

Simplify your income statements with Xero

Creating income statements manually takes time and leaves room for errors, especially as your business grows. Xero's accounting software generates profit and loss reports automatically from your real-time financial data, so you always have an up-to-date view of your business's performance.

With Xero, your transactions are categorized as they come in, which means your income statement builds itself as you run your business. You can pull a report for any period, compare performance across months or quarters, and share statements with your accountant or lender in just a few clicks. Get one month free.

FAQs on income statements

Here are answers to frequently asked questions about income statements.

What is the difference between an income statement and a balance sheet?

An income statement shows your revenue, expenses, and profit over a specific period, while a balance sheet shows your assets, liabilities, and equity at a single point in time. The income statement measures performance; the balance sheet measures financial position.

How often should you prepare an income statement?

Most small businesses benefit from preparing income statements monthly. Quarterly and annual statements are also common and are typically required for tax filing and loan applications.

What is the difference between a single-step and multi-step income statement?

A single-step income statement subtracts total expenses from total revenue in 1 calculation. A multi-step income statement separates operating and non-operating activities and calculates intermediate figures like gross profit and operating income.

What is the difference between net income and gross profit?

Gross profit is your revenue minus the cost of goods sold, showing what you earn before overhead costs. Net income subtracts all remaining expenses, including operating costs, interest, and taxes, giving you the true bottom line.