Multi Step Income Statement

The steps

Each stage subtracts one group of costs and names what is left. Shown with the figures of a made-up furniture retailer for one year:

1. Net sales to gross profit

Net sales are sales after returns and discounts. Taking off what the goods cost leaves gross profit: what the retailer earns on the furniture itself.

2. Gross profit to operating income

Operating expenses are the costs of running the business: selling expenses such as sales staff and advertising, and administrative expenses such as office salaries, rent and software. What remains is operating income, the profit from the core business.

3. Operating income to income before taxes

Items outside the main business come next. Here interest earned of 1,200.00 and interest paid of 6,500.00 net to (5,300.00).

4. Income before taxes to net income

Subtracting income tax gives net income, the bottom line. A small business owner who calls the same report a profit and loss statement often stops after the second step, because many small businesses have little other income, and a pass-through business usually pays income tax on the owners' returns instead of its own.

One example, both ways

Here is the retailer's year as a full multi step statement, then the same figures in a single step layout. Both end at 54,905.00.

Not accounting, tax or legal advice. Check every figure before you sign or submit it. Some lenders require a statement prepared by an accountant.

The single step version puts every revenue in one group and every expense, including cost of goods sold, interest and income tax, in another:

Nothing changed but the grouping. What the multi step layout adds is the story in between: a gross margin of 40.0%, and operating income of 74,800.00 before interest and tax.

Where each cost goes

Most of the work in a multi step statement is deciding which stage a cost belongs to. A few rules settle almost every line:

• Cost of goods sold: what the goods you sold cost you, including freight to get them in and, for a maker, the materials and direct labor used to make them.
• Selling expenses: costs of winning and delivering sales, such as sales staff, commissions, advertising, showroom costs and delivery to customers.
• Administrative expenses: costs of running the business as a whole, such as office salaries, rent for the office, accounting fees, insurance and software.
• Other income and expense: anything outside the main business, such as interest earned and paid, or a gain or loss on selling equipment.
• Income tax expense: tax on the business's own profit, which appears only when the business itself pays it.

When a cost could fit two places, pick one and use it every year. Consistency matters more than the perfect answer, because the point of the layout is to compare one year with the next.

The margins it shows

Each stage gives a margin when you divide it by net sales. For the retailer, gross margin is 40.0% (244,800.00 of 612,000.00), operating margin is 12.2% (74,800.00) and net margin is 9.0% (54,905.00). A single step statement shows only the last of these.

The gap between them tells its own story. Here, 40 cents of every sales dollar survive the cost of the furniture, but selling and administrative costs take another 27.8 cents, and interest and tax take the rest of the difference. If the operating margin slips while the gross margin holds, the running costs are growing faster than sales.

Single step or multi step

If someone else will read the statement, such as a lender, multi step is usually the better choice. For your own monthly check-in, single step is often enough.

In short, pick single step when you only need the bottom line, and multi step when you sell products or want to show gross profit and operating income. Both reach the same net income, so you can start with single step and switch later without changing a single figure.

A services business without cost of goods sold

A consultant, a designer or an agency sells time, not goods, so the first step changes. Start at revenue and go straight to operating expenses, or add a cost of services line for costs that rise with each job, such as subcontractors or freelancers hired for a project. With a cost of services line, the first subtotal is still called gross profit.

From there the stages are the same: operating income, other income and expense, income before taxes and net income. Our profit and loss statement examples include a freelancer and a driver laid out without cost of goods sold.

Whether a services business shows a cost of services line is a judgment call. If most of your costs rise and fall with each project, such as freelancers, materials for a job or hosting for each client, a cost of services line makes your gross margin meaningful. If most costs are fixed, such as your own time, rent and software, skip it and let operating income carry the story. Either way, keep the same layout from year to year so the margins compare.