The Income Statement
Revenue - Expenses = Net Income
Why This Matters
A business owner sits down at the end of the year and asks the simplest question: “Did we make money?”
That's what the income statement answers.
It's the scorecard of business performance. Did revenue exceed expenses? By how much? Which products/services are profitable? Which are costing too much?
Without an income statement, you have no idea if you're actually making money or just going through the motions. The income statement is how every business knows if it's winning or losing.
What Is an Income Statement?
The income statement (also called the profit and loss statement or P&L) is a financial report showing revenues, expenses, and net income for a specific period.
The Formula:
Revenue
- Expenses
= Net Income (or Net Loss)
The insight is powerful: It shows not just whether you made money, but where it came from and where it went.
The Standard Format
Here's what a complete multi-step income statement looks like:
ACME CORPORATION
Income Statement
For the Year Ended December 31, 2026
REVENUE
COST OF GOODS SOLD
OPERATING EXPENSES
OTHER INCOME/EXPENSES
This is a multi-step income statement showing Gross Profit, Operating Income, and Net Income separately.
The Key Sections
Revenue
Revenue is income from the company's main business activities. Record revenue when earned, not when cash is received (accrual basis).
Includes:
- Sales Revenue – Income from selling products
- Service Revenue – Income from providing services
- Rental Revenue – Income from renting assets
Cost of Goods Sold (COGS)
COGS is the direct cost of producing goods that were sold. It's tied directly to production.
Includes:
- Raw materials
- Direct labor in manufacturing
- Manufacturing overhead
Does NOT include:
- ✗Salaries for salespeople (operating expense)
- ✗Rent (operating expense)
- ✗Advertising (operating expense)
Gross Profit
Gross Profit = Revenue - COGS. This is profit from core business operations before considering operating expenses.
Operating Expenses
Operating expenses are the costs of running the business that don't directly produce goods.
Includes:
- Salaries & Wages – Employee compensation
- Rent – Office/store space
- Utilities – Electricity, water, gas
- Depreciation – Equipment wearing out
- Marketing & Advertising – Promotion costs
Operating Income
Operating Income = Gross Profit - Operating Expenses. This is profit from the core business operations.
Other Income & Expenses
Items not from core operations: interest income, interest expense, gains/losses on asset sales.
Includes:
- Interest income from investments
- Gains on sale of assets
Does NOT include:
- ✗Interest expense on loans
- ✗Losses on sale of assets
Income Tax Expense
The tax owed to the government based on taxable income. This gives us the final Net Income—the bottom line.
Real-World Example: ABC Coffee Shop
Let's build a full income statement for ABC Coffee Shop for 2026:
Gather the Data
Revenue:
- Coffee Sales: $120,000
- Food Sales: $50,000
Inventory:
- Beginning: $8,000
- Purchases: $72,000
- Ending: $12,000
Operating Expenses:
- Salaries: $40,000
- Rent: $12,000
- Utilities: $4,000
- Supplies: $3,000
- Depreciation: $2,000
- Marketing: $5,000
Other:
- Interest Income: $200
- Interest Expense: $1,200
- Tax Rate: 25%
Calculate COGS
Build the Statement
ABC COFFEE SHOP
Income Statement
For the Year Ended December 31, 2026
REVENUE
COST OF GOODS SOLD
OPERATING EXPENSES
OTHER INCOME/EXPENSES
ABC Coffee Shop earned $26,250 in net profit for the year. The business is profitable!
Key Metrics from the Income Statement
These ratios help you understand profitability at different levels:
Gross Profit Margin
Gross Profit ÷ Revenue
Example: $102,000 ÷ $170,000 = 60%
Meaning: For every $1 of sales, 60¢ covers COGS, leaving 40¢ for expenses and profit.
Why it matters: Shows production efficiency. Higher margin = better pricing power or lower costs.
Operating Profit Margin
Operating Income ÷ Revenue
Example: $36,000 ÷ $170,000 = 21%
Meaning: For every $1 of sales, 21¢ remains as operating profit.
Why it matters: Shows operational efficiency. Higher margin = better business model.
Net Profit Margin
Net Income ÷ Revenue
Example: $26,250 ÷ $170,000 = 15%
Meaning: For every $1 of sales, 15¢ is net profit after all expenses and taxes.
Why it matters: Shows bottom-line profitability. This is what the owner actually keeps.
Multi-Step vs. Single-Step Format
Multi-Step Format
Shows gross profit and operating income as separate lines.
Shows profitability at different levels
Easier to analyze
Industry standard for most businesses
Single-Step Format
Divides into just two sections: Revenue and Expenses.
Simpler
Fewer calculations
✗Less detail for analysis
Reading an Income Statement: What to Look For
1. Revenue Growth
Year 1: $100,000
Year 2: $120,000
Growth: 20%
2. Expense Control
Revenue up 20%
Expenses up 6.25%
Under control
3. Gross Margin Consistency
Year 1: 60% margin
Year 2: 59% margin
Slight decline
4. Operating Leverage
Revenue up 20%
Net Income up 35%
Good scaling
Income Statement Formats by Industry
Retail
Emphasizes: Gross Margin, Inventory Turnover
Key: COGS (often 50-70% of revenue)
Service
Emphasizes: Labor costs, Utilization
No COGS section (no inventory)
Manufacturing
Emphasizes: Gross Margin, Factory Overhead
Detailed COGS breakdown
Income Statement vs. Cash Flow: The Difference
Income Statement (Accrual)
- Revenue when earned (not necessarily received)
- Expenses when incurred (not necessarily paid)
- Shows profit/loss
Cash Flow (Cash Basis)
- Only counts cash in and cash out
- Ignores accruals
- Shows actual cash movement
Example:
You complete a $10,000 project in December. Customer will pay in January.
Income Statement (December):
+$10,000 revenue
Cash Flow (December):
+$0 cash
Both are correct—they measure different things.
Key Takeaway
The income statement answers the fundamental business question: “Did we make money?” It shows revenue, subtracts expenses, and reveals net income. By analyzing its components—gross profit, operating income, and net income—you can understand profitability at different levels and compare performance across periods. But remember: profit and cash are different. An income statement can show strong profits while the business runs out of cash.
Test Your Understanding
1. Which section of the income statement shows profit before operating expenses?
2. A company has revenue of $500,000 and COGS of $300,000. What is Gross Profit Margin?
3. Which of the following is NOT typically included in COGS?
4. A company reports $100,000 net income but $50,000 was paid in taxes. What is Income Before Taxes?
5. True or False: A company can show a profit on the income statement while running out of cash.
Ready to Practice?
Build your own income statements
You now understand how to read and build an income statement. The Practice Lab is where you'll take trial balances, calculate COGS, prepare income statements, and analyze profitability.
Try the Practice Lab