ARTICLE TABLE OF CONTENTS
What is a Single-Step Income Statement?
Income statements help businesses determine its financial performance over a period of time. These statements are also used for tax reporting purposes. It’s important to keep income statements in an organized and safe place for many years because they may be needed at a later time for financial or legal reasons. The income statement forms part of the financial statements and will usually be for the period of a year, commencing from the date of the previous years’ income statements.
A single-step income statement is very simple. All it shows is a list of revenue totals and expenses. The expenses are subtracted from revenue totals to calculate net income. At a minimum, General Accepted Accounting Principles (GAAP) requires revenues, expenses and net income to be disclosed on the face of a single-step income statement. Because of its simplicity, it is used by many small businesses, solo entrepreneurs, contract workers, and freelancers.
The following line items are disclosed on the face of a multiple-step income statement Revenues:
- Net Income
With the single-step income statement, there is no need to keep detailed reporting of expenses and income from operating and non-operating perspectives. And while this greatly simplifies accounting processes, it does not provide enough detail to help achieve the highest level of operational efficiency possible like a multiple-step income statement does.
When trying to maximize the value or efficiency of something (such as a business operation), it’s helpful to know everything you’re working with.
What is a Multiple-Step Income Statement?
As an alternative, the following line items are presented on the face of a multiple-step income statement:
- Gross Profit (Sales less Cost of Goods Sold)
- Operating Expenses
- Operating Income
- Non-Operating Income or Expenses (or ‘Other’)
- Net Income
A multiple-step income statement uses multiple steps to determine a company’s net income. The statement provides detailed reporting of a business’s revenue streams and expenses.
There are several types of businesses that use multiple-step income statements. This is particularly true of complex businesses with large operations.
An example of an entity that may prefer to use a multiple-step income statement is a manufacturing company. This type of company usually favors the multiple-step statement because it has multiple sources of revenue and the statement allows them to see income and expenses that come from essential activities as well as non-essential.
With a multiple-step income statement, a business’s financial health is broken down into multiple parts, thus allowing you to see how to best distribute resources across all operations as well as determine which operations need greater efficiency.
Using the multiple-step income statement is often advantageous over using a single-step income statement. This is because the multiple-step provides a close look at the revenues and expenses from a two-part angle: operating and non-operating. In doing this, business owners and investors receive a better view of a company’s actual profitability levels as well as the cost of operational processes.
How to Calculate a Multiple Step Income Statement
There are three steps in the multiple-step income statement calculation:
Step 1: Calculate Gross Profit
In the first step that you calculate the gross profit or gross margin. To do this, you take the cost of goods sold and subtract its value in the statement’s first section instead of listing it under the other expenses section. It is the gross profit that helps see whether a company’s operational processes like manufacturing and selling products lead to a profit or loss. Creditors can use the gross profit of a company to decide whether to loan the company money or resources. The gross profit also helps creditors determine the debt obligation terms. For a lot of lenders, the higher the gross profit, the better the debt obligation terms they will offer.
Furthermore, investors use the gross profit value of a company to paint a picture of a company’s overall health and to see how profitable its primary business operations are. It’s important to note that when calculating gross profit, the only factors included are cash inflow from selling goods and the amount of cash that is spent on purchasing goods. No other expenditures are included.
Step 2: Calculate Operating Income
The second step is when you calculate operating income. You can subtract all operating expenses from your gross profit to see what the operating income is. Your selling and administration expenses that come from your operating activities are listed in the second step. A lot of times, the section will include marketing expenses, freight charges, payments to sales personnel, and more.
The administrative expenses listed are those that come from processes that aren’t directly related to the selling of goods. This is also where you list your office personnel payroll and such things as rental expenses for building space or equipment.
Step 3: Calculate Net Income
The last step involves calculating net income. This is the step that adds up all non-operating income and expenses and adds their value to operating income to determine a net income value. If the non-operating income and expenses don’t result in a value higher than zero, then their value is subtracted from operating income to determine net income value.
Any business-related income and expenses that aren’t directly related to your primary business operations are listed in the third section. One example of a non-operating expense is the payout of money to an aggrieved party due to a loss in a lawsuit claim made against your business. An example of a non-operating income is a payout from an insurance company to serve as compensation for the loss of a business asset.
In order for income or expenses to be categorized as non-operating, the gain or loss has to arrive from an extraordinary item that isn’t usually categorized as an ordinary part of the business’s operations.
What is a Consolidated Income Statement?
A consolidated income statement is used by entities that have multiple divisions or subsidiaries. It’s important to know that the word consolidated is used loosely by a lot of companies, particularly in financial statement reporting. They use the word loosely when referring to their aggregated reporting of their business’s collective operations. But the Financial Accounting Standards Board says that consolidated reporting only exists when an entity is structured as having a parent company and one or more subsidiaries.
Public companies must follow the Generally Accepted Accounting Principles that are provided by the Financial Accounting Standard’s Board. When a company must report internationally, it is also required to stay within the guidelines detailed in the International Financial Reporting Standards provided by the International Accounting Standards Board. The guidelines listed in both of these standards and principles are very specific and strict. This is why it’s always a good idea to hire experienced accountants to handle the statements.
A lot of entities choose to file consolidated income statements on a year-to-year basis. Companies often choose this type of statement because of the tax advantages that it brings as well as other advantages that sometimes arise. Generally, the ability to file a consolidated income statement is based on whether on ownership percentage that a parent company has in one or more subsidiaries. To qualify as a parent company with a subsidiary, a business usually has to have at least 50% ownership in the subsidiary. If it does, then it can file a consolidated income statement. It’s very important to know, however, that a company doesn’t always have to have at least 50% ownership. Even with less ownership, if it can prove that the other company’s management is directly and heavily aligned with the parent company’s decision-making processes, then it may be able to use a consolidated income statement.