Income Statement vs. Profit and Loss Statement (With Uses)
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Businesses regularly create financial statements that offer insight into their financial performance during a reporting period. An income statement, or a profit-and-loss statement, is a crucial accounting document that summarises a company's performance so a business can understand its profitability. Learning what these statements typically contain and how you can use them is essential if you're interested in the financial industry. In this article, we define what an income statement vs. profit-and-loss statement is, explain some reasons to use them, discuss the components of these statements and outline how to create one.
Income statement vs. profit-and-loss statement
If you're wondering what an income statement vs. profit-and-loss statement is, they're two interchangeable names for the same document, which details how much money a company earned in sales and how much money they spent, revealing their ultimate profit. Businesses of many sizes use income statements to record their earnings and expenditures over a finite period. Companies can create an income statement to summarise their financial performance throughout a month, quarter or fiscal year. This statement is beneficial for stakeholders, analysts and internal personnel to review a company's performance.
While it's commonly known as an income statement or a profit-and-loss statement, this document has many other names, including:
statement of earnings
statement of financial results
statement of operations
net income statement
income and expense statement
Reasons to use an income statement
This document can be beneficial in many business situations, such as:
An income statement can be a simple tool an accounting team can use to review a company's financial performance to inform decision-makers. This document can also help a company's senior management to understand what areas of a company to focus on developing. For example, if a company notices that its supply costs are abnormally high, it can consider negotiating better prices or changing vendors.
Transparency with investors
It's important for companies to learn the opinions of key stakeholders to understand if they approve of business activity. Many companies provide their investors access to income statements to keep them informed about their financial performances. Public companies are also required to create and provide these statements to investors and the public.
If a company wants to get a business loan, lenders may want to learn more about their business activities to determine if they meet certain criteria. An income statement helps a lender calculate the financial risk of lending an organisation money. By reviewing a series of income statements, financial analysts can forecast a company's future earnings and growth to determine its ability to repay a loan.
Financial analysts may review income statements to learn how a company is performing compared to its competitors. Professionals with a high level of business acumen may analyse these statements to draw insights into companies' management and operations. For example, an income statement may reveal overspending in advertising while sales decrease while a competitor's income statement shows the opposite. Financial analysts may use this information to inform their predictions about the future of a market.
Components of an income statement
Here are elements that an income statement typically includes:
Total revenue is the overall amount of money a company earns during a period. These statements typically differentiate between operational revenue, which is money earned through sales, and non-operational revenue, which is money earned outside of a company's principal operations like securities investment. Non-operational income can skew a company's total revenue and create an inaccurate view of its performance. Denoting whether income is operational or non-operational helps accountants, lenders and analysts gain a clearer understanding of a business's success and ability to grow.
Cost of goods sold
The cost of goods sold (COGS) is the price required to produce the products a company sells. This may account for supplies, equipment and labour. COGS typically excludes overhead costs like marketing or rent unless these expenses are unique to the product or service being produced. Calculating COGS can help businesses identify waste and formulate strategies to reduce production-related expenses.
An itemised list of expenses is a vital part of an income statement, and most companies choose to categorise their expenses to offer additional context. Like revenue, a company can separate its expenses into operational and non-operational costs. Operational costs include any expenses directly associated with revenue generation like labour, supplies, marketing and technology. Non-operational costs may include interest paid on loans.
Many businesses note on their income statement if an expense is an extraordinary expense, also known as a one-off expense. An extraordinary expense is an abnormally large cost accrued because of unique circumstances that may never occur again. For example, a natural disaster rendering equipment useless may necessitate a large purchase of new machinery. Separating extraordinary expenses from regular expenses may help financial professionals set realistic expectations for future costs.
Fixed assets may change in value over time, which is relevant information for investors and lenders. Depreciation is a method that accountants can use to spread the costs of an asset across its useful life. While this factor may be outside a company's control, it can impact the overall financial health of the organisation.
Net profit and loss
You can calculate the net profit by subtracting total expenses from total revenue, leaving net profit or loss. This figure is vital because it signifies the company's overall performance and ultimate profitability. It's possible to earn a high total revenue but accrue more expenses than revenue resulting in a net loss. Many businesses aim to increase their net profit over time to earn the trust of investors and lenders and demonstrate a high likelihood of continued growth.
You can subtract COGS from total revenue to determine gross profit. While most professionals consider net profit to be a clearer indicator of financial performance than gross profit, gross profit can help companies understand the profitability of their business model. For example, if a company has a significantly lower net profit than gross profit, this may show the company has significant expenses outside of producing its goods. This allows a company to identify areas of its business model that it can improve.
How to create an income statement
Here are six steps you can follow to create an income statement:
1. Select the reporting period
Income statements only include data during a specific limited period. Accountants often generate income statements every month, quarter or year, and the reporting period you choose can depend on industry regulations and the needs of stakeholders. Determine your reporting period so you can begin gathering relevant data.
2. Use accounting software to create a balance report
A trial balance report is a simple document that shares the current balance in all company accounts during the reporting period you select. The trial balance report includes the information you may need for creating an income statement and offers a high-level overview of a company's financial status. Various accounting software provides functions to generate this report.
3. Add up your revenue
Examine your trial balance report for line items, which represent incoming payments. Using an accounting program may help you ensure you calculate revenue correctly. Remember to include revenue from all sources, including sales, investments and interest.
4. Calculate the COGS
Add up the price spent on producing the goods or services a company sells. If you work for a large company that operates in many sectors, repeat the process for each product. Include labour, supplies, machinery and vendor expenses if they're specific to a good or service.
5. List your expenses
Create an itemised list of operational and non-operational expenses accrued during the reporting period, even if the company has yet to pay them. You can detail these expenses to the extent you want according to your obligations. You can denote one-off expenses or categorise expenses by their sources like payroll, marketing and rent.
6. Calculate gross and net profit
If you want to calculate gross profit, subtract COGS from total revenue. Subtract total expenses from total revenue to determine net profit. List these figures clearly for readers to review.
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