The multi-step income statement provides companies with detailed information about the health and profitability of their business. See if this income statement is right for your business.
One of the three main financial statements, the income statement measures business performance. Also known as the profit and loss account, the income statement provides an overview of income and expenses incurred during a given period.
While the single-step income statement is suitable for small businesses, other businesses will appreciate the level of detail offered in a multi-step income statement.
Overview: What is a multi-step income statement?
The multi-step income statement provides detailed reports of your business income and expenses in several steps to arrive at the bottom line. Multi-step income statement items include revenue, cost of goods sold, and expenses, which are calculated to arrive at net income.
Unlike the simple one-step income statement, the multi-step income statement distinguishes between operating and non-operating income and expenses, giving business owners and investors greater insight into operations. and corporate profitability levels.
The multi-step income statement requires a calculation in three steps:
Step 1: Calculation of Gross Profit or Gross Margin: The first step in a multi-step income statement is to calculate Gross Profit or Gross Margin. This is done by subtracting the cost of goods sold in the first section of the statement rather than listing it with other expenses.
Step 2: Calculation of operating profit: The second step is to calculate the operating profit for the period. This is done by subtracting operating expenses from gross profit.
Step 3: Calculating net income: The last step is to calculate net income. Now that you have the total of gross profit and operating income, you need to add any non-operating income or expenses and add or subtract these amounts from your operating income to get the net income.
Income Statement vs Multi-Step Income Statement: What’s the Difference?
The one-step income statement is the simplest income statement format, calculating income totals and subtracting expenses to arrive at net income.
The easiest income statement to prepare, the one-step income statement provides an overview of income and expenses, which most small businesses will find sufficient.
More complex than its one-step counterpart, the multi-step income statement uses a three-step process to calculate net income which is used in the preparation of a single-step income statement. Here are some other ways the multi-step income statement is different:
1. Ease of preparation
The one-step income statement is the easiest income statement format to prepare, focusing primarily on net income.
On the other hand, the multi-step income statement requires three steps, which gives more details about business operations, which makes it especially valuable for investors and financial institutions.
2. Ability to calculate gross profit
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 who need more detailed information about business profitability and financial performance.
Since gross margin only focuses on revenue and cost of goods sold, business owners have a better idea of the true profitability of their core business.
3. Ability to calculate operating profit
Another measure available from the multi-step income statement is operating income. Like gross profit, operating profit provides business owners with more detailed information about the profitability of the business rather than just focusing on net profit.
Should your small business use a multi-step income statement?
If you are a sole proprietor, freelancer or consultant, a one-step income statement is sufficient. The one-step income statement is easier to prepare and provides the information you need.
However, if your business is in the growth phase or you are looking to obtain a bank loan or attract investors, a multi-stage income statement provides details that are missing in the single-stage income statement.
If you’re not sure which income statement is right for you, see the table below for guidance:
How a Multi-Step Income Statement Works
Preparing a multi-step income statement requires more time and work than its counterpart, so let’s get started:
Step 1: Determine your accounting period
Income statements allow you to choose a monthly, quarterly, or annual income statement period, depending on your needs.
Step 2: Run a trial balance
Run a trial balance for the same period that your income statement will cover. If you are creating a multi-step income statement for the first quarter of 2020, your trial balance should be prepared for the same quarter.
Step 3: Calculate total revenue
Add up all of your income for the income statement period. Be sure to only include revenue from sales, as any other revenue will be calculated at a later stage.
Step 4. Calculate cost of goods sold
The next step when preparing a multi-step income statement is to calculate the cost of goods sold. This includes all materials required for manufacturing as well as direct labor costs for employees directly involved in the manufacturing process.
If you buy products to resell them, your cost of goods sold is the cost of purchasing those products.
Step 5. Calculate gross profit/gross margin
Subtract the cost of goods sold from your revenue to get your gross profit or gross margin. This number tells you how efficient and profitable your main business is.
Step 6: Calculate operating expenses
When calculating operating expenses, do not include expenses already included in the cost of goods sold, such as direct labor and purchased materials.
Step 7. Calculate operating profit
The next step is to subtract your total operating expenses from your gross profit to arrive at operating profit. Operating income measures the amount of operating income excluding all non-operating income and expenses.
Step 8. Calculate other income and expenses
If you have non-operating income or expenses, they will need to be added to your income statement. These may include the following:
- interest income
- Interest expense
- Gain or loss on investments
You can also include taxes in this section, or if you are looking to create EBIT (earnings before tax), you can create a separate section for taxes.
Step 9. Calculate net income
The final step in preparing your multi-step income statement is to determine your net income. This is done by subtracting the totals of other income and expenses from your operating income.
Multi-step income statements are worthwhile
If you are a sole proprietor or an independent contractor, you can certainly use a one-step income statement. But for established businesses as well as companies looking to apply for a loan or attract investors, a multi-step income statement is worth the extra steps.
If you’re still struggling to keep track of your business income and expenses in multiple books, it might be time to upgrade to accounting software. To see some of the best products available, be sure to check out The Ascent’s accounting software reviews.