Single-step income statements report the revenue, expenses, and profit (or loss) of a business during a specific period. Companies with many different sources of revenue should create a multi-step income statement. This would include large manufacturing businesses as well as large, complex retailers.
Single-step income statements calculate the business’s net income by subtracting losses and expenses from gains and revenue. These statements don’t have a high level of detail and are useful when making an assessment that depends on profits or net income. As discussed above, we saw how multi-step income statements are useful for investors and creditors to get a detailed insight into a company’s financial performance and its pros and cons. The attached example also helped us understand the different components used in such a statement. The three key measures of profit in a multi-step statement are gross profit or gross income, operating profit or operating income, and net income, also referred to as profit, earnings, or the bottom line. The statement shows the line items gross profit and operating income, which are metrics commonly looked at by management, investors, and creditors.
Disadvantages of Single-Step Income Statements
A multi-step income statement classifies the revenues, expenses, losses, and gains into operating and non-operating sections (commonly known as heads). As you can see, the multi-step income statement gives the reader much more information about the company’s financial position than the single step income statement. Also, its compulsory for publicly traded companies to prepare the multi-step income statements based on the government’s requirements for statutory compliance. We’re now ready to calculate operating income by subtracting the remaining operating expenses from gross profit.
The first step to creating the statement is gathering the necessary information. The adjusted trial balance is a listing of the company’s accounts and their balances after adjusting journal entries have been made. Other sources of information for the statement might include, for example, documentation that details the company’s https://www.bookstime.com/articles/capital-stock core business activities so as to differentiate between operating and non-operating items. The major headings on a multi-step income statement are revenue, gross profit, operating income, non-operating income, and net income. Together, these sections provide a detailed overview of a company’s financial performance.
The Formula of Multi-Step Income Statement
Operating income measures the amount of income from operations excluding all non-operating income and expenses. One of the biggest differences between a single-step income statement and a multi-step income statement is the ability to calculate gross profit. This metric is important for business owners that need more detailed information on both business profitability and financial performance. The final step in creating a multi-step income statement is calculating net income. Before you prepare your income statement, you need to select a reporting period.
The following will use theoretical numbers to explain the details of preparing a multi-step income statement. Unlike a single-step format, multi-step formats don’t only focus on net income but offer an additional level of detail by calculating two more income-related figures. When calculating operating expenses, don’t include any expenses already included in the cost of goods sold, such as direct labor and materials purchased. If you’re a sole proprietor, freelancer, or consultant, a single-step income statement is sufficient.
Step 2: Calculate Operating Income
Given its higher level of information content, the multi-step format is usually preferred over the single step format (which does not incorporate sub-totals and so can be more difficult to read). The amount of detail provided in multi-step formats can be a drawback as it’s a time-consuming and more complex way of preparing an income statement compared to using a single-step format. Be sure to only include revenue from sales, as any other revenue will be calculated in a later step. However, if your business is in a growth stage, or you’re looking to obtain a bank loan or attract investors, a multi-step income statement provides details that are missing from the single-step income statement.
With the single-step layout, details are left out of the presentation and calculation of net income. The layout of the multi-step will allow the user to see the performance of the operating and non-operating components. Finally, when arriving at net income, you are able to see what the business’s core activities produced and what the effect of non-core activities had net income. Hence, the potential investors and creditors will gain better clarity of your company’s financial footing, which helps boost your chances of getting funding and bank loans. For instance, if your business is charged with 10% of tax expense from a total of $60,000 of net income, thus, your business will have to bear $6,000 of tax expense. The income statement for a merchandiser is expanded to include groupings and subheadings necessary to make it easier for investors to read and understand.
Generally, businesses that use multi-step income statements are large, complex companies. Most small businesses and sole proprietorships can get by with just a single-step income statement, since their operations and accounting tend to be straightforward. Investors also use the gross profit to determine the profitability of primary business activities and the general health of the company.
For example, they include several income and expense categories, they present net income as a separate line item, and they often include a reconciliation of net income to cash flow from operating activities. Multi-step income statements also typically include several non-operating items, such as interest expense and income multistep income statement example taxes. Non-operating revenues and expenses are then added to or subtracted operating income in order to calculate income before taxes. Non-operating items are those revenues and expenses that do not pertain to the company’s normal operations such as dividend income, interest income and expense, and income tax expense.