How to prepare an income statement

The income statement is a core financial document that gives you a clear picture of financial performance and operational efficiency — whether you're budgeting for growth, pitching to investors, or preparing for tax season.

What is an income statement?

An income statement (also known as a profit and loss statement) tracks your company’s revenue, operating expenses, gross profit, and net income over a specific period. It tells the story of how money moves through your business—and whether you’re operating efficiently or leaking cash.

Income statements are crucial for business owners, CFOs, and investors as they provide a clear view of a company’s profitability. The statement also helps with budgeting and identifying areas where your business can improve its operating income and reduce cost of goods sold (COGS).

How income statements are used

Income statements are commonly used as profit and loss statements (P&L) to calculate a company’s profitability metrics. The net income figure at the bottom is especially important, as it feeds into key financial ratios such as return on assets (ROA) and return on equity (ROE).

Beyond profitability, income statements reveal how efficiently a company is managing its expenses. Expenses are categorized to be examined individually later if you’re looking for areas where you can cut costs. Income statements from different reporting periods can also be compared to see how revenue and expenses have changed.

The U.S. Securities and Exchange Commission (SEC) requires income statements and the other reports listed above for all companies trading publicly on the stock exchange. These reports give investors and shareholders the transparency they need to make financial decisions. Failure to produce financial reports could lead to heavy fines and delisting on the stock exchange.

For private companies, income statements are useful for tracking revenue and expenses, determining whether your business is producing an income, and analyzing costs. It’s a good idea to get in the habit of creating them in case you ever want to go public. Consistently preparing income statements is also beneficial if your company plans to raise capital, apply for loans, or eventually go public.

Key components of an income statement

An income statement includes several key line items that help break down your company’s financial performance. Here's a breakdown:

How to prepare an income statement

The three main elements of an income statement are revenue, expenses, and profit. Profit, which is typically listed last on an income statement, is used to calculate net profit margin. That’s the origin of the term “bottom line.”

Step #1: Choose the reporting period

Corporations set a fiscal year-end when filing their articles of incorporation, and that's typically when the annual report is due. However, income statements aren’t limited to year-end reporting. Public companies file them quarterly, aligned with tax deposits. Private businesses may also prepare monthly statements for internal use. Be sure to choose the reporting period before you begin.

Step #2: Calculate your revenue

Under GAAP companies must use the accrual method, which records revenue when it’s earned—not when it’s received. This distinction is important for businesses offering net payment terms, as it tracks income based on invoice dates, not actual cash flow.

Step #3: Calculate COGS

COGS includes the direct costs associated with producing your product or delivering your service—such as labor, materials, and distribution. Some companies list COGS under the revenue section to show gross margin before expenses, while others categorize it under expenses. Either approach is acceptable as long as it's consistent.

Step #4: Calculate gross margin

Gross margin helps determine pricing efficiency. To calculate it, subtract COGS from gross revenue, then divide by gross revenue:

Gross Margin = (Gross Revenue – COGS) / Gross Revenue

This figure shows how much profit your business retains after covering direct production costs.

Step #5: Factor in total operating expenses

Operating expenses include salaries, rent, utilities, transportation, advertising, and marketing. If you use automated accounting system, these should already be categorized for you. If not, you'll need to organize them manually to ensure accuracy. Categorization is critical if you want to get the most out of your income statement.

Step #6: Calculate operating income

Operating income is the result of subtracting total operating expenses from total revenue. It reflects your company’s core profitability before taxes and interest. If you exclude depreciation and amortization (non-cash expenses), the resulting figure is known as EBITDA.

Step #7: Account for taxes

Calculate the income tax owed on your operating income. If you’re using a spreadsheet like Excel, you can apply a formula to automate this—for example, a 25% tax rate would be written as [= (Cell Number) *.25.]. This simplifies estimating tax liability for quarterly deposits or planning.

Step #8: Calculate net income

To find net income, subtract taxes and any applicable interest, depreciation, and amortization from operating income. This final figure shows whether your business earned a profit during the reporting period—and provides essential insight for executives, stakeholders, and investors.

How to analyze income statement

To analyze an income statement, look at how revenue is changing over time, whether gross and operating margins are improving or shrinking, and how much of the revenue turns into actual profit—this helps you understand if the company is growing, managing costs well, and ultimately becoming more or less profitable.

Gross profit

The gross profit margin is a key metric to assess the profitability of your core business activities. It’s calculated as:

Gross Profit Margin = (Gross Profit / Total Revenue) × 100

A higher gross profit margin means your business is efficient at generating revenue from its direct costs. If this figure is low, you might want to evaluate cost of goods sold (COGS) or pricing strategies.

Operating income

Operating income measures your company’s profitability from regular operations, excluding non-operating expenses like taxes or interest. If your operating income is shrinking, it could indicate increasing operating expenses, such as higher administrative expenses or inefficiencies in operations.

Net income

The ultimate figure on the income statement is net income, which shows your business’s overall profitability and allows you to understand the final outcome of all your business activities. If your net income is negative, consider reducing unnecessary expenses or increasing sales revenue.

EBITDA and EBIT

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) and Earnings Before Interest and Taxes (EBIT) are often used for further analysis. These metrics exclude non-cash expenses like depreciation and amortization, providing a clearer picture of operational profitability.

Example of an income statement

Here’s a sample income statement for a small business:

This statement shows that the business generated $500,000 in revenue, with $250,000 going toward the cost of producing goods. After deducting operating expenses, the company earned $130,000 in operating income. The net income is $95,000 after factoring in taxes and non-operating expenses.

Common income statement mistakes and how to avoid them

Even with experience, it's easy to make small errors that can distort your income statement—and in turn, lead to poor business decisions, incorrect tax filings, or miscommunication with stakeholders. The key to accurate financial reporting lies in catching these common mistakes early and building safeguards into your process.

1. Misclassifying expenses

One of the most common mistakes is incorrectly categorizing operating and non-operating expenses. For example, placing interest or tax expenses under operating costs can inflate operating income and mislead stakeholders about core business performance.

How to avoid: Use a standardized chart of accounts and ensure your team is trained on what qualifies as operating vs. non-operating expenses. Conduct regular reviews of expense classifications.

2. Overlooking depreciation and amortization

These non-cash expenses reduce the value of your assets over time, but they’re often forgotten or incorrectly calculated—leading to overstated net income.

How to avoid: Automate depreciation and amortization tracking using accounting software, and review your asset schedules quarterly to ensure values are up to date.

3. Underestimating income tax

Tax miscalculations can cause significant discrepancies in net income, especially when rates vary based on your business structure, location, or deductions.

How to avoid: Confirm that the correct tax rate is applied for the reporting period and jurisdiction. Work with a tax advisor or use tax-integrated accounting tools to avoid missteps.

4. Reying solely on spreadsheets

Manual data entry in Excel or Google Sheets opens the door to human error—especially in more complex statements with multiple categories or periods.

How to avoid: Use finance automation tools to auto-categorize transactions, reduce manual entry, and ensure accuracy across reporting periods.

Enhance the accuracy and efficiency of your income statement with Ramp

Accurate financial reporting is essential for understanding your business's financial health. By automating the preparation of your income statement, you can eliminate manual errors, streamline your workflow, and gain real-time insights into your financial performance.

Ramp’s accounting automation software simplifies this process by integrating your financial data, automating the creation of income statements, and providing actionable insights into profitability. It transforms your accounting operations with powerful automation, reducing the time spent on manual data entry and reconciliation.

Empower your team to make informed decisions faster while Ramp takes care of the tedious tasks.