In accounting, the income statement, which is also referred to as the profit and loss statement, is prepared with the purpose of illustrating to managers and investors whether or not the business was profitable over the course of an accounting cycle (a month, a quarter, a year, etc.). The business’ profitability is based on two simple criteria: the revenue gained from selling goods or services, and the expenses paid by the business, which affect the revenue negatively. There are two ways to prepare this crucial financial statement, the multiple-step method, and the single-step method, which is what we will be discussing today. If you’re new to financial statements, this course on interpreting statements understand, interpret, and analyze these important features of accounting.
For those of you that may be responsible for your small business’ bookkeeping, and want to familiarize yourself with, or just brush up on the income statement, or you’re simply curious about accounting basics, today we will spotlight single-step income statement. In the process, we’ll explain how it’s constructed, what differentiates it from the multi-step method, the benefits and drawbacks of using it, and finally, we’ll show you an example of a single-step income statement. If you happen to be a small business bookkeeper, either for your own business, or someone else’s, and need a few refresher courses, this article on money management software will help get your finances in order, and this course on small business accounting will get you acquainted with the basics of useful subject.
A Bit More on This Financial Statement
Let’s begin today by delving into what the income statement is, then focus specifically on the single-step method. As we said before, the income statement is ubiquitous in the accounting profession, and, along with the balance sheet, the statement of cash flows, and the statement of owner’s equity, is essential in communicating the financial health of a business. There are three parts that make up an income statement:
- Revenues: The first thing you will notice when looking at an income statement is the list of the business’ revenues. Quite simply, revenue is any income that the business earns from conducting its normal activities, selling goods and/or services to its customers. Other forms of revenue may include fees, rent, interest, or any other miscellaneous accruals of money.
- Expenses: These are the costs associated with doing business. These transactions may fall under the headings of cash outflows, use of assets, or incurred liabilities. Specific examples of expenses include: cost of goods sold, depreciation, employee salaries, taxes, rent, and advertising, among many others.
- Net Income: The final part of the income statement, net income is basically revenue minus expenses. If you’ve ever heard the phrase “bottom line”, it’s referring to net income, because it is literally the bottom line of the income statement, and shows whether the business is profitable or not.
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Single-Step vs. Multi-Step
Now that you know a bit of general information about the income statement, let’s move on to the two methods. While one is simpler to do than the other, they both end up with the same amount of net income in the end, and they simply differ on the methodology used to get that number.
- Single-Step Method
The star of the show today, the single-step income statement is the easier of the two methods to deal with, whereas instead of multiple steps, here, you are dealing with a much simpler process. The single-step method is less concerned with detail as its counterpart, and simply has the three sections mentioned above (revenues, expenses, and net income). The underlying equation behind this method is (revenues + gains) – (expenses + losses) = net income. The types of businesses that would benefit from using this method over the other include service-based businesses, as well as smaller companies, such as sole proprietorships, partnerships, etc. Sometimes, a larger company will provide a single-step statement in addition to the multi-step in order to cover all their bases.
- Multi-Step Method
The major difference between this method and the previous is that there is much more detail in the multi-step method. The revenues in the first part of the statement are presented in much greater detail, with the cost of goods sold being subtracted from sales to find gross profit (revenues). When listing the expenses on a multi-step statement, operating expenses (selling, advertising, etc.) are separate from other expenses, while operating income and other income are separate, as well. Larger companies with more complex business dealings need to account for these complexities in their accounting, and as a result, probably will prefer this method.
Drawbacks and Advantages
While the single-step income statement is simple to read and understand, and has its place in the accounting world, there are few drawbacks that counter it’s benefits, mostly due to the lack of detail offered by the single-step.
- Easy to Prepare The major reason for why the single-step method may be preferable is its simplicity. Small business owners may not like the more complex multi-step method, especially if those in charge of the books are the owners themselves, or others not properly trained in accounting and bookkeeping.
- Quick The time it takes to prepare the single-step statement as opposed to the multi-step is much quicker. If a smaller business was using a first-time bookkeeper, the single-step method would not be too difficult to put together, but if for some reason they had to provide a multi-step, they would either need to train their current bookkeeper, or hire a new one altogether.
- Less Confusing Again, assuming we are dealing with a smaller business with a newer bookkeeper, there is much less likelihood of a major mistake happening with the single-step method. This can also end up saving business money in the long run.
- Lacks Gross Profit The revenues and expenses of a business must be classified and broken down in order to calculate gross profit. That may be ok for some people, but for other, larger businesses, that simply is insufficient for their accounting needs.
- Operating and Non-Operating Income Also falling under the heading of “lacking detail”, there is no differentiation between the types of income realized by the business. By not detailing the income brought in by the company, there is less opportunity to analyze the business deeply, which may look bad to those interested in the financial details, such as potential investors.
The Single-Step Income Statement in Action
Now that you have a good idea of what the single-step income statement brings to the table, it’s time to actually show you what it looks like. We’ll start off by listing the steps (it’s a bit more than one) in preparing this statement, then illustrate a sample statement. The income statement, as with any other financial statement, may be prepared by hand, or with a handy accounting program. If you’re unsure of your abilities with this type of program, this course on QuickBooks for small business will introduce you to this handy accounting software.
- Step 1
As with any properly prepared financial statement, it must have a heading. At the top of the statement should be the name of the company, below that, the type of statement it is (“Income Statement”), and finally the time the statement covers. Remember that this is not a specific date, but a period of time, such as a month, year, or quarter.
- Step 2
Next, list the business’ revenues for the period. First, list sales revenues, then any other pertinent revenues. Then, add them up next to the heading “Total Revenue”.
- Step 3
Next come the expenses. There should be the heading “Expenses”, then under that, list them all. Add them up next to the heading “Total Expenses”.
- Step 4
Finally, subtract the total expenses from the total revenues, and you have your net income.
|For the year ended December 31, 2013|
Cost of Goods Sold
Even though it’s actually a bit more than one step to prepare the single-step income statement, it is quite simple and effective, especially for smaller businesses and new bookkeepers. Even though some of the concepts in accounting can get a bit involved and complex, the basics are pretty cut and dry. Even a very important tool like the income statement involves simple addition and subtraction, though it speaks volumes about the life and performance of a company. If you happen to be starting a business and won’t be able to afford a bookkeeper, and will have to do it yourself, don’t fret, because this course on the basics of bookkeeping will have you ready in no time.