How to prepare an income statement: A guide with an example

If you want a clear view of how your business is performing financially, an income statement is the place to start. It breaks down your revenue, expenses, and profits over a specific period, helping you make informed decisions backed by real data. Whether you're running a small local business or managing a global team, income statements keep you on top of your finances and offer deeper insight into the story behind your numbers.

In this guide, we'll explain what an income statement is, including the elements it includes and a step-by-step walkthrough of how to prepare one. We'll also share a simple income statement example that you can use to create your own.

What is an income statement?

An income statement—also called a profit and loss (P&L) statement or an income and expense statement—is a financial report that shows how much your company earned and spent over a specific period, whether a month, a quarter, or a full fiscal year. The goal is to assess how well your business performed during this time. Are you generating net income? Are operating expenses outpacing total revenue? The income statement helps answer these questions by organizing your revenues and expenses into a clear performance snapshot.

To fully understand your business’s financial health, it’s helpful to compare the income statement to the balance sheet and cash flow statement. The balance sheet captures your company’s assets and liabilities at a specific point in time, while the cash flow statement tracks how money moves in and out of your accounts. Together, these three financial statements provide a comprehensive view of your business’s profitability.

What does an income statement include?

An income statement uses a few key accounts—also called income statement accounts—to break down your company’s earnings and costs into specific categories. These include total revenue, operating expenses, and other line items that help you track progress, spot trends, and calculate key metrics like gross profit and net income. Here’s what you’ll typically find:

• Revenue: Sometimes labeled as gross sales or top-line revenue, this is the total amount earned from sales, services, or other income sources before deducting any costs.
• Cost of goods sold (COGS): These are the direct costs of delivering your product or service, such as materials, labor, and production. You use this figure to calculate gross profit.
• Gross profit: This is the difference between revenue and COGS. It highlights how efficiently your business delivers its core offering.
• Operating expenses: This includes recurring costs like salaries, tools, software, and employee benefits. For many companies, compensation and related costs, such as health insurance premiums and employer payroll taxes, make up the largest share. These costs appear as a major component of operating expenses on the income statement, not to be confused with a total compensation statement (which is for internal employee communications).
• Operating income: Also known as EBIT (earnings before interest and taxes), this is what remains after subtracting operating expenses from gross profit. It reflects how profitable your business is before factoring in financing expenses and income tax.
• Interest and taxes: These represent financial obligations to lenders and governments. Interest expense stems from debt, while income tax depends on location and corporate structure. 
• Net income: This is the bottom line—also known as net profit. This is what’s left after you’ve deducted all expenses, interest, and taxes. It’s one of the most closely watched indicators of financial health and profitability. Depending on your goals, you might choose to reinvest, save, or distribute your net income through profit sharing.
• Earnings per share (EPS): For public companies, this shows how much net income the company earned per outstanding share.

You might also see lines for nonoperating items (income or expenses unrelated to your primary activities), such as gains from asset sales or interest income. Meanwhile, depreciation and amortization may fall under COGS or operating expenses, depending on how you used the asset.

Why are income statements useful?

An income statement ties your company’s financial performance to real-world decisions. Whether you're budgeting, reporting to stakeholders, or checking your progress, it brings structure and clarity to your financial statements. Here's how organizations typically use income statements:

Track profitability over time

Reviewing multiple income statements side by side makes it easier to spot changes in revenue, expenses, and net income. This long-term view helps you understand whether you’re building a sustainable business or whether costs are quietly cutting into profitability.

Make smarter operational decisions

With a clear view of operating expenses and gross profit, you can adjust spending, shift resources, or reevaluate pricing strategies. Companies often use the data that income statements provide to identify opportunities for improving efficiency and rebalancing budgets.

Evaluate business unit or product performance

Segmenting income statements by department, region, or product line allows you to pinpoint what drives earnings. This visibility supports better forecasting and resource planning, especially for growing global teams.

Prepare for audits and tax filings

Because income statements track total revenue, expenses, and income tax in a standardized format, they serve as a go-to document for tax reporting and financial audits. Ensuring that they’re accurate and up to date reduces surprises during compliance reviews and simplifies year-end filings, including documents like W-2 forms.

Build trust with investors and lenders

Lenders, boards, and investors often request income statements when companies apply for loans, secure equity financing, or issue financial reports. They help external stakeholders understand how your business is performing and whether it’s positioned for growth.

How to prepare an income statement in 8 steps

Creating an income statement doesn’t require a finance degree—just careful attention to detail. Use this step-by-step process to build your income statement with confidence:

1. Choose the reporting period

Start by selecting the time frame the income statement will cover—monthly, quarterly, or annually. Monthly statements help with day-to-day decisions, while quarterly or annual ones give a clearer view of your business’s long-term financial performance.

2. Calculate total revenue

Add up all sources of revenue during the period, including sales, services, and other income streams like asset sales or interest. If you're creating a statement for a specific department or product line, include only the revenue that pertains to the scope.

3. Subtract the cost of goods sold (COGS)

Calculate the direct costs of delivering your product or service, including raw materials, labor, packaging, and contractor fees. (Service-based businesses often refer to this as the cost of services sold or COSS.) If you work with contractors or freelancers, using independent contractor pay stubs helps document and track these costs accurately. 

4. Determine gross profit

Subtract COGS from total revenue. This gives you gross profit, which shows how efficiently your core offering generates income before factoring in day-to-day operating expenses.

5. Add up operating expenses

These are the indirect business costs, like salaries, rent, utilities, marketing, and software subscriptions. For many companies, compensation is a major line item. Understanding the difference between salary and total compensation helps you record these figures correctly. If your business offers noncash perks like gym memberships or commuter benefits, record the cost as part of your operating expenses. Some of these benefits may count as imputed income for your employees, meaning they’re taxable even if no money changes hands.

6. Calculate pretax income

Next, subtract your operating expenses from your gross profit to determine your pretax income (also known as EBIT—earnings before interest and taxes).

7. Account for interest and taxes

Factor in what your business owes in interest on loans or credit lines and applicable income tax. These amounts vary depending on location and tax structure, so make sure these amounts reflect local and national requirements.

8. Find your net income

Subtract interest and taxes from your pretax income to calculate your net income—your final profit or loss for the period.

Income statement formats and example

There are two common income statement formats: single-step and multi-step.

A single-step income statement keeps things simple. It groups all revenues at the top and all expenses below and then subtracts one from the other to show net income. This clean layout works well for smaller businesses or startups with fewer line items to track.

A multi-step income statement gives you more detail. It separates operating income from nonoperating activities and includes subtotals like gross profit and operating income. This format follows the standard income statement formula, showing where revenue comes from, how costs flow through the business, and how they affect profitability.

Here’s a sample of a multi-step income statement for a fictional business, based on the structure we walked through earlier. The figures represent performance for Q1 2025:

Income statement Q1 2025

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