As a business owner, you have a lot on your plate. Managing sales, keeping ahead of competitors, and solving problems. It can be hard to keep up with the details, which is why it is important to closely track the financial performance of your business’s many moving parts.
That’s where a multi-step income statement can help. Here’s how multi-step income statements work, and how you can use one for your business.
What is a multi-step income statement?
A multi-step income statement is a report of a business’s revenue or sales, its expenses, and the resulting final net profit or loss. It is called a multi-step statement because it shows a business’s profitability in a series of steps. Each step involves a calculation of income minus relevant expenses at particular points in the income statement.
Larger businesses, especially businesses with more than one product line, almost always use multi-step income statements. All corporations with publicly traded stock use the process, because it’s required by regulators and follows generally accepted accounting principles (GAAP).
The income statement is one of a trio of essential financial statements, including the balance sheet, which lists a company’s assets and liabilities, and the cash flow statement. Using the multi-step process for detail and clarity is important because a company must be able to square its income statement with its balance sheet and cash-flow statement.
Multi-step vs. single-step income statement
A multi-step statement distinguishes between a company’s daily operating activities and non-operating activities. Non-operating activities can include a range of things, from interest income on investments to a gain on an asset sale to costs for settling litigation or shutting an inefficient factory.
Compared with a multi-step income statement, a single-step income statement is a shorter, less detailed report of a business’s profitability. It uses a single calculation to arrive at net income:
Total sales – Total expenses = Net income
There are no measures of intermediate profitability such as gross profit or operating income, both of which are important elements of the multi-step format.
Small businesses with simple operations, such as sole proprietors and partnerships, are more likely to use a single-step statement because it’s simple to prepare and read. Income isn’t categorized by source, nor are expenses segmented into production costs, overhead costs, or other non-operating costs. Some small business owners might prepare a single-step statement themselves without using a bookkeeper or an accountant.
But for larger businesses, a single-step statement is insufficient, providing too little information about how profit is generated and making analysis difficult for outsiders such as lenders and investors who consider whether to provide capital.
The multi-step statement requires more time and effort to prepare, but it provides more detail about a business, which allows for greater insight into a business’s performance over time. It also makes it easier to perform comparative analysis against competitors.
Key elements of a multi-step income statement
A multi-step income statement has three main components. Each section contains what are known as line items and is structured as follows:
A business records the following entries in this section, almost always in this order:
- Sales or revenue. This is the amount generated from selling the business’s products or services.
- Cost of goods sold (COGS). These are the expenses directly associated with making products or delivering services.
- Gross profit. This is the first level of profitability. It’s derived by subtracting COGS from sales or revenue.
- Selling, general, and administrative expenses (SG&A). Also known as overhead, these are the expenses of running the business not directly associated with production.
- Operating profit or income. This is the second step of profitability. It’s calculated by subtracting SG&A from gross profit.
Non-operating activities section
This section includes various types of income and expenses not tied directly to the business’s daily operations. These may be labeled in a variety of ways, but they fall into two broad categories:
- Non-operating income. This includes stock dividends, interest received, rental income, and extraordinary gains such as the profitable sale of an asset, or payment received from a legal or insurance settlement.
- Non-operating expenses. Examples include payments made to settle a legal or insurance claim, reducing the value of assets (writedowns), costs of reorganizing the business (restructuring), and interest on debt.
Net income is the final step of profitability. In a multi-step statement, it’s calculated as:
Operating profit + Non-operating income – Non-operating expenses – Interest – Taxes = Net income
For a publicly traded company, the multi-step income statement will include per-share calculations, or the amount of net income attributable to each share outstanding. This helps a company’s investors understand the value of their respective shares as part of the net income pie.
Multi-step income statement structure
Multi-step income statements adhere to a well-established structure. Reading from top to bottom the statement almost always includes:
1. Formal name
This is the company or business’s name as it appears on its tax forms, bank accounts, legal documents and, in the case of public companies, its filings with the Securities and Exchange Commission.
2. Statement type
The document will clearly indicate it’s an income statement rather than another financial statement, such as a balance sheet or cash flow statement.
3. Reporting period
Many companies prepare quarterly and annual income statements based on the calendar. Others use a fiscal year with start and end dates that don’t align with the calendar. In all cases, the statement will indicate the period end date.
4. Line items
These are the entries, line by line, for income and expenses. There may be a couple of entries or many, depending on the size and complexity of the business.
5. Segments and subtotals
This is the breakdown of operating activities and non-operating activities. Gross profit and operating profit are calculated here.
6. Net income
After all sources of income and expenses are tallied, and taxes are deducted, the result is net income or net loss. Net income also is sometimes referred to as net profit, earnings, or the bottom line.
Example of a multi-step income statement
Let’s use a hypothetical lawn and garden business. This is how it might present an income statement with the multi-step process:
|Lawn & Garden Co.|
|Quarter ended 06/30/2023|
|(In US dollars)|
|Cost of goods sold|
|Total cost of goods sold||-500,000|
|Selling, general, administrative expenses|
|Office supplies, equipment||-10,000|
|Total selling, general, administrative||-300,000|
|Interest received on note||10,000|
|Gain on sale of asset (land)||20,000|
|Loss, payment of insurance settlement||-10,000|
|Total, non-operating activities||20,000|
|Income before interest and taxes||$220,000|
|Interest paid on business loan||-10,000|
|Net income before taxes||$210,000|
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Multi-step income statement FAQ
What types of businesses use a multi-step income statement?
Larger businesses, particularly manufacturers and multi-product businesses, use multi-step statements because they’re more informative and useful than a single-step statement.
What subtotals are commonly reported on multi-step income statements?
Multi-step income statements typically include subtotals for operating activities and for non-operating activities, or those outside of the business’s primary operations. Within primary operations, two key subtotals are for cost of goods sold (COGS), which determines gross profit, and selling, general, and administrative (SG&A) costs, which determines operating profit.
Why are multi-step income statements important?
Multi-step statements provide the detail necessary for analysis and making decisions, both internally by business managers and externally by lenders and investors. It also meets the standards regulators require of publicly traded companies, which must adhere to generally accepted accounting principles, or GAAP.
What measures of profit are reported on a multi-step income 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. A related measure called earnings before interest and taxes, or EBIT, appears on some statements, allowing comparison of profitability among companies, some of which may have debt interest expenses while others may not.