Operations of an Income Statement

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  • 0:04 Income Statement
  • 0:49 Multi-Step vs. Single-Step
  • 2:40 Line Items
  • 7:41 Lesson Summary
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Lesson Transcript
Instructor: Natalie Boyd

Natalie is a teacher and holds an MA in English Education and is in progress on her PhD in psychology.

How do you know how much money your company, or a company you're interested in investing in is making? In this lesson, we'll look at the art of the income statement, including different types and the major information to be found on them.

Income Statement

Graham is CEO of a company that's about to go public and sell shares. That's very exciting but very daunting, too. Graham wants the public to pay a lot of money for his company's shares, and he needs to communicate with them about how well the company is doing and what a good investment the company stocks would be. To do this, he will use an income statement.

An income statement is a statement that lists a company's income and expenses for a set period of time. Most companies put out five income statements per year: one for each quarter and one for the year. To help Graham put together an income statement, let's look closer at the two statement formats and what's included on an income statement.

Multi-Step vs. Single-Step

Graham wants to put together an income statement for his company, so he gets several of them to use as examples. But Graham is confused, they look very different from each other! Some of them include things called 'gross income' and 'operating income,' and others just include 'net income.' What's going on?

There are two major types of income statements, the multi-step income statement and the single-step income statement. A multi-step income statement includes four measures of profitability at four different places on the statement. These measures of profitability are different types of income.

The four types of income included on a multi-step income statement are: gross income, operating income, pretax income and net (or after tax) income. We'll look at each one in a moment, but for now, just know that that multi-step income statements include all four.

In contrast to the multi-step statement, a single-step income statement lists only net income at the bottom of the statement.

Both single-step and multi-step income statements include the same basic revenue and expenses, but in a multi-step statement, income is calculated at different points on the statement, whereas in a single-step statement, it is only calculated once. This is where the different types of statements get their names: income is calculated in different (multiple) steps on a multi-step statement and only one single time on a single-step statement.

Of course, if Graham looks at single-step income statement, he could figure out what the operating income is, if he wanted to. All the same information on what's coming in and what's going out is the same, so he'd just calculate it the same way he might calculate it on a multi-step statement.

Line Items

Graham likes the multi-step income statement because it not only breaks down revenue and expenses but also calculates income at four different stages. But he's not quite sure how to make a multi-step income statement. What is included?

There are many lines in a multi-step statement. They are:

1. Net sales:
Net sales are all the sales dollars brought in. That is, all the revenue for a company. If Graham's company sold $2,000,000 worth of product last year, he will write in $2,000,000 on the first line.

2. Cost of sales:
Companies have to make or buy the items that they sale. For example, Graham's company manufactures products. They have to pay for all the materials and equipment used to make the products. For a retail store, the cost of sales includes the price they pay for inventory.

3. Gross income:
Gross income, which is also called gross margin or sometimes gross profit, is the net sales minus the cost of sales. In other words, Graham should take the $2,000,000 from line one and subtract from that the amount in line two. If the cost of sales is $350,000, for example, then the gross margin of Graham's company last year was $1,650,000.

4. Operational expenses:
These are the expenses that are required to keep the company running, such as salaries of employees, utility bills and other expenses like that.

5. Operating income:
After gross income, operating income is the second of the four incomes included on the multi-step income statement. Operating income is calculated by subtracting operational expenses from the gross margins. For example, if Graham's company spent $250,000 last year on operational expenses, he would subtract that from $1,650,000, which would make his company's operating income $1,400,000.

6. Interest expense:
Many companies have debts. The interest expense line lists the cost of those debts. For example, last year, Graham's company paid $50,000 in interest on a business loan. That goes on this line.

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