What is an income statement?
The income statement shows you whether you have made a profit or a loss by selling your goods or services. The income statement compares the expense with the income, for example the production costs of your goods are compared with the sales you have achieved by selling the goods. The difference (balance) from this comparison shows whether you have made a profit or a loss.
The comparison always takes place for a certain period, usually for a fiscal year. The income statement then starts all over again.
A distinction is made between the single-step income statement and the multi-step income statements:
The single-step income statement only shows income, expenses and net profit. This enables the financial development of a company to be read quickly and easily from the single-step income statement.
Here is an example of a single-step income statement:
The multi-step income statement, on the other hand, follows a multi-step process for calculating corporate profit in which operating income and expenses are separated from non-operating income and expenses. The multi-step income statement shows, among other things, how efficiently a company generates a profit from its main business activity. Thus the multi-step income statement offers a particularly good insight into the financial situation of the company. In Switzerland, the law stipulates that every company must present a multi-step income statement in its annual financial statement.
In the following, we explain in detail the multi-step income statement, in particular the two- and three-step income statements.
The multi-step income statement explained
The multi-step income statement is drawn up on the basis of the chart of accounts and shows how solid a company is. This is because the interim results of the multi-step income statement, such as gross or operating profit, provide information on the profitability and financing of the business.
Multi-step income statements include two- and three-step income statements, which can be presented in the form of reports or accounts.
Format of the multi-step income statement
To ensure that annual financial statements are fully recognized by auditors, there are clear guidelines for the multi-step income statement which must be observed.
If you do not use approved accounting software and create your income statement manually, it is imperative that you choose the most appropriate format so that there are no misunderstandings regarding the interpretation of the results/profits:
In order for all calculations to be visible, the corresponding key data must be determined correctly by clearly marking the intermediate items. This can be done, for example, by using a double line or a colored marking that highlights the individual items and makes them easily visible.
A high degree of order is particularly important in the case an annual audit of the balance sheet is carried out by external auditor, so that no subsequent audits are called for by the tax office.
The two-step income statement
A two-step income statement consists of an operating area and a neutral area. The areas summarize the expenses and income and finally present the company's profit. On the left side only the expenses are shown and on the right side only the income.
Step 1: The operating area includes, among other things, sales proceeds, the use of raw materials and the company's interest expenditure. The depreciation, wages and salaries are also included as items. The first part of the two-step income statement concludes with the presentation of the operating profit.
Step 2: This is now followed by the neutral area. First of all, the rental income and property expenses are added/subtracted to/from the operating profit. Direct taxes are deducted as the last item. The neutral area ends with the company profit.
The three-step income statement
A three-step determination of income consists of a total of three steps. Like the two-step calculation, the three-step income statement consists of an operating area, a neutral area and a trading area.
Step 1: The trading area includes the income and expenditure from goods, from which the gross profit is calculated.
Step 2: This is followed by the operating area, where personnel expenses and depreciation, among other things, are now deducted from the result. At the end of the second area is the operating profit or loss.
Step 3: This is now followed by the neutral area, which in turn takes into account real estate expenses and income as well as securities expenses and income. Once all positions have been added and subtracted, the final corporate profit or loss is obtained.
Difference between income statement and balance sheet
You can use double-entry bookkeeping to create both a balance sheet and an income statement. They are the main components of a company's annual financial statement. But what is the difference? Balance sheet and income statement simply explained:
In the balance sheet you can see where your money comes from and where you invested it. The assets and liabilities are compared in the balance sheet. The balance sheet is based on the balance sheet date: It shows you the assets of your company on a specific date. This makes the balance sheet particularly suitable for obtaining information about your current financial situation, for example.
The income statement (or IS) is different: It tells you whether you have made a profit or a loss in a given period by comparing your income with your expenses. If the right side (income) is higher than the left side (expenses), you have made a profit in the period under consideration, otherwise you have made a loss. This is why the income statement is often referred to as the profit and loss account.
The following graph illustrates the difference between the income statement and the balance sheet: