When it comes to financial statements, each communicates specific information and is needed in different contexts to understand a company’s financial health.
The income statement is one of the most important financial statements because it details a company’s income and expenses over a specific period. This document communicates a wealth of information to those reading it—from key executives and stakeholders to investors and employees. Being able to read an income statement is important, but knowing how to generate one is just as critical.
Here’s an overview of the information found in an income statement, along with a step-by-step look at the process of preparing one for your organization.
Financial statements are important documents that provide valuable insights into a company’s financial health. They allow business owners investors lenders and other stakeholders to track revenues, expenses, assets, liabilities and cash flow over a specific period of time.
Learning how to make financial statements may seem intimidating at first. But with the right knowledge and tools, anyone can put together accurate financial reports.
This comprehensive guide will walk you through the entire process of making financial statements, step-by-step.
Overview of the Main Financial Statements
There are three main financial statements that all businesses should prepare on a regular basis:
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Income Statement – Also known as a profit and loss statement, this shows your revenue, expenses and net income (profit or loss) over a period of time
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Balance Sheet – This provides a snapshot of your company’s assets, liabilities and equity at a specific point in time.
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Cash Flow Statement – This tracks how cash is generated and spent by your business over a period of time.
These core financial statements are the foundation for understanding the financial position and performance of a company Some businesses also prepare a Statement of Retained Earnings and Statement of Owners’ Equity, But the three main reports listed above are essential
Now let’s look at how to make each of these key financial statements, step-by-step:
How to Make an Income Statement
An income statement shows whether your business made a profit or took a loss over a specific period of time. Here are the steps for creating one:
1. Choose Your Reporting Period
Income statements typically cover a span of one month, one quarter or one year. Decide on the time frame you want your income statement to cover.
2. Determine Your Revenue
Add up all the revenue your business earned from sales, services and other sources during the reporting period. Some examples of revenue include:
- Product sales
- Service income
- Membership/subscription fees
- Advertising income
3. Calculate the Cost of Goods Sold
The cost of goods sold (COGS) is the direct costs of producing or purchasing the goods and services your company sold during the reporting period. For example, a retailer’s COGS would include inventory costs. A service-based business may not have a COGS.
To calculate COGS:
Beginning inventory + Inventory purchases – Ending inventory = COGS
4. Determine Gross Profit
Take your revenue and subtract COGS to find your gross profit.
Gross profit = Revenue – COGS
This shows the profitability of your core business operations before taking operating expenses into account.
5. Determine Expenses
Add up all the operating and non-operating expenses your business incurred during the reporting period. Operating expenses are the day-to-day costs of running your business, like salaries, rent, supplies, marketing, etc. Non-operating expenses include items like interest expense and taxes.
6. Calculate Total Income
Subtract total expenses from your gross profit to determine your net income for the period.
Net income = Gross profit – Total expenses
If your net income is positive, your business made a profit. If it’s negative, your business faced a net loss over the reporting period.
7. Determine Taxes and Interest
Account for income taxes and interest paid/earned in the appropriate sections of the income statement. The final number after these adjustments is your net income.
That covers the essential steps for preparing an income statement. Now let’s look at creating a balance sheet.
How to Make a Balance Sheet
A balance sheet provides a financial snapshot of your business at a specific point in time. Follow these steps to create one:
1. Choose a Reporting Date
Balance sheets reflect your company’s financial position on the last day of a month, quarter or year. Pick the date you want this balance sheet to represent.
2. List Your Current Assets
Current assets include cash or assets that will be converted to cash within 12 months, such as:
- Cash and cash equivalents
- Short-term investments
- Accounts receivable
- Inventory
- Prepaid expenses
Total up the current assets your business owns as of the reporting date.
3. List Fixed Assets
Fixed assets are long-term assets vital to your company’s operations, like:
- Land
- Buildings
- Manufacturing equipment
- Furniture
- Vehicles
Calculate the total fixed assets minus any accumulated depreciation as of the reporting date.
4. Determine Intangible Assets
Intangible assets lack physical substance but provide value to your company. Common examples include:
- Brand recognition
- Intellectual property (patents, trademarks, copyrights)
- Goodwill
Add the total value of all intangible assets.
5. Sum Total Assets
Add up your current assets, fixed assets and intangible assets to determine total assets.
6. List Your Current Liabilities
Current liabilities are financial obligations that must be paid off within 12 months, such as:
- Accounts payable
- Accrued expenses
- Customer deposits
- Notes payable
- Current portion of long-term debt
- Income taxes payable
Total your current liabilities as of the reporting date.
7. List Long-Term Liabilities
Long-term liabilities are debts and other non-current financial obligations, including:
- Long-term debt
- Deferred income tax
- Deferred revenue
Calculate the total of long-term liabilities.
8. Sum Total Liabilities
Add current and long-term liabilities together to determine total liabilities.
9. Calculate Owners’ Equity
Owners’ equity is assets minus liabilities. It represents the total value of the business to its owners as of the reporting date.
There are a few components of owners’ equity:
- Paid-in capital – The amount invested by the owners through purchasing shares; does not include earnings.
- Retained earnings – Business income that is retained rather than paid out to owners as dividends.
- Treasury stock – Company shares repurchased from shareholders.
Add together paid-in capital, retained earnings and treasury stock. Then subtract any treasury stock to determine total owners’ equity.
10. Sum Total Liabilities and Equity
This sum should always equal your total assets figure from Step 5. If not, double check your calculations to find any errors.
Once the total liabilities and total equity equal total assets, your balance sheet is complete!
Moving on, let’s go through the steps to prepare a cash flow statement.
How to Make a Cash Flow Statement
The cash flow statement shows how cash entered and exited your business during the reporting period. Follow these steps to create one:
1. Choose Your Reporting Period
Like other financial statements, cash flow statements cover a specific time frame – typically monthly, quarterly or annually.
2. Calculate Cash from Operating Activities
The operating activities section tracks the cash used and provided by your company’s normal business operations during the reporting period.
Start with net income from your income statement. Then make adjustments for non-cash items like depreciation. Finally, adjust for changes in working capital, including:
- Accounts receivable
- Inventory
- Accounts payable
- Accrued expenses
The end result is your net cash from operating activities.
3. Determine Cash from Investing Activities
Investing activities include cash flows from:
- Purchasing or selling long-term assets like property, plants and equipment
- Investing in securities
- Earning interest income
Subtract cash outflows from inflows to calculate net cash from investing activities.
4. Calculate Cash from Financing Activities
The financing section includes cash flows from taking loans or repaying debt, interest payments, dividend payments, issuing new shares, and other financing-related cash inflows and outflows.
Tally the net amount of cash from financing activities during the reporting period.
5. Sum Cash Flows
Add together your net cash from operations, investments and financing to determine the net increase or decrease in cash for the reporting period.
6. Factor in Beginning and Ending Cash Balances
Add the beginning cash balance to your overall cash increase or decrease. The result is your ending cash balance for the reporting period.
And with that, your cash flow statement is complete!
Tips for Producing Accurate Financial Statements
Follow these tips for ensuring your income statement, balance sheet and cash flow statement are as accurate as possible:
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Maintain up-to-date financial records throughout the reporting period. This makes it much easier to produce financial statements.
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Proofread your statements carefully before finalizing them. Check for errors in formulas, amounts entered, balances carried forward, etc.
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Have someone else on your accounting team review the statements as a second set of eyes.
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Compare your year-end financial statements to the previous year’s reports to check for
What Is an Income Statement?
An income statement is a financial report detailing a company’s income and expenses over a reporting period. It can also be referred to as a profit and loss (P&L) statement and is typically prepared quarterly or annually.
Income statements depict a company’s financial performance over a reporting period. Because the income statement details revenues and expenses, it provides a glimpse into which business activities brought in revenue and which cost the organization money—information investors can use to understand its health and executives can use to find areas for improvement.
An income statement typically includes the following information:
- Revenue: How much money a business took in during a reporting period
- Expenses: How much money a business spent during a reporting period
- Costs of goods sold (COGS): The total costs associated with component parts of whatever product or service a company makes and sells
- Gross profit: Revenue minus costs of goods sold
- Operating income: Gross profit minus operating expenses
- Income before taxes: Operating income minus non-operating expenses
- Net income: Income before taxes
- Earnings per share (EPS): Net income divided by the total number of outstanding shares
- Depreciation: Value lost by assets, such as inventory, equipment, and property, over time
- EBITDA: Earnings before interest, depreciation, taxes, and amortization
Calculate Cost of Goods Sold (COGS)
Next, calculate the total cost of goods sold for any product or service that generated revenue for your business during the reporting period. This encompasses direct and indirect costs of producing and selling products or services, including:
- Direct labor expenses
- Material expenses
- Parts or component expenses
- Distribution costs
- Any expense directly tied to the production of your product or service
FINANCIAL STATEMENTS: all the basics in 8 MINS!
How do you write a financial statement?
Print a final version of the financial statements. Based on this information, write footnotes to accompany the statements. Finally, prepare a cover letter that explains key points in the financial statements. Then assemble this information into packets and distribute them to the standard list of recipients.
What is a financial statement?
Financial statements are reports that summarize important financial accounting information about your business. There are three main types of financial statements: the balance sheet, income statement, and cash flow statement. Together, they give you—and outside people like investors—a clear picture of your company’s financial position.
What is the process of preparing financial statements?
The preparation of financial statements involves the process of aggregating accounting information into a standardized set of financials. The completed financial statements are then distributed to management, lenders, creditors, and investors, who use them to evaluate the performance, liquidity, and cash flows of a business.
How do I prepare an income statement?
FreshBooks provides free template income statements that are pre-formatted for your needs. All you need to do is fill in the empty fields with the numbers you’ve calculated. No stress, just results. These topics will show you how to prepare an income statement: What Is An Income Statement?
