Preparing an income statement means gathering your revenue and expense accounts, choosing a format, and organizing them into a report that shows whether your business earned a profit or a loss over a specific period. Whether you’re building one for the first time or refining your process, the steps follow a logical sequence: start with your accounting records, make necessary adjustments, classify each line item, and calculate your way down to net income.
Gather Your Financial Records
Everything on an income statement comes from your general ledger, which is the master record of every financial transaction your business has recorded. Before you start, you need a trial balance: a worksheet listing every account in your ledger along with its debit or credit balance. The trial balance confirms that your total debits equal your total credits, which means your books are mathematically in order.
If you use accounting software, generating a trial balance is usually a one-click report. If you keep books manually, you’ll pull the balance from each ledger account and list them in two columns. The accounts you’ll focus on for the income statement are revenue accounts (sales, service income, fees earned) and expense accounts (rent, wages, supplies, utilities, cost of goods sold). Balance sheet accounts like assets, liabilities, and equity appear on the trial balance too, but they belong on a different statement.
Make Adjusting Entries First
A trial balance only reflects transactions you’ve already recorded. It won’t capture revenue you’ve earned but haven’t invoiced yet, or expenses you’ve incurred but haven’t paid. These gaps distort your income statement, so you need to post adjusting entries before you build the report.
Common adjustments include:
- Accrued expenses: Bills you owe but haven’t received or paid yet. If your business used electricity in October but won’t get the bill until November, you still need to record that expense in October. You debit the expense account and credit accounts payable.
- Accrued revenue: Work you’ve completed or goods you’ve delivered but haven’t been paid for yet. If you finished a consulting project in March and the client pays in April, March’s income statement should include that revenue.
- Depreciation: The portion of a long-term asset’s cost allocated to the current period. A $12,000 piece of equipment with a 10-year useful life generates $1,200 in annual depreciation expense.
- Prepaid expenses: Payments you made in advance that need to be spread across the periods they cover. A $6,000 insurance premium paid upfront for 12 months means $500 belongs in each month’s income statement.
After posting these entries, run an adjusted trial balance. This updated version is what you’ll actually use to build the income statement.
Choose Your Format
Income statements come in two standard formats, and the right choice depends on your business size and how much detail you need.
Single-Step Format
The single-step income statement groups all revenues together at the top and all expenses together at the bottom, then subtracts one from the other to arrive at net income. That’s it. There’s one subtraction, which is why it’s called “single-step.” This format works well for freelancers, sole proprietors, and small businesses with straightforward operations. It’s fast to prepare and easy to read, but it doesn’t show you intermediate figures like gross profit or operating income.
Multi-Step Format
The multi-step income statement separates operating activities from non-operating activities and calculates several profit figures along the way. Most publicly traded companies use this format because it gives investors and managers a clearer picture of where profits come from. You’ll see gross profit (revenue minus cost of goods sold), operating income (gross profit minus operating expenses), and finally net income (after adding or subtracting non-operating items and taxes). The tradeoff is that it takes more time and requires careful classification of each line item.
Classify Your Line Items
Getting the categories right is the core skill in preparing an income statement. Every revenue and expense account from your adjusted trial balance needs to land in the correct section.
Revenue goes at the top. This includes sales revenue, service revenue, and any other income directly tied to your primary business activities. If you run a bakery, revenue is what customers pay for bread and pastries. If you’re a consulting firm, revenue is your consulting fees.
Cost of goods sold (COGS) captures the direct costs of producing whatever you sell. For a product business, this includes raw materials, direct labor, and manufacturing overhead. For a service business, it might include the labor costs of employees who deliver the service. Subtracting COGS from revenue gives you gross profit.
Operating expenses are the costs of running your business that aren’t directly tied to producing a product or service. Rent, office supplies, marketing, insurance, administrative salaries, and depreciation all fall here. Subtracting operating expenses from gross profit gives you operating income.
Non-operating items sit below the operating income line. Interest income, interest expense, dividend income, gains or losses from selling assets, and similar items go here. These are real financial events, but they don’t reflect your core business performance. Interest expense and any amortization of debt discount should appear as their own line items rather than being buried in a general category.
Income tax expense typically appears as the last deduction before net income.
Build the Statement Step by Step
Start with a header that includes your business name, the words “Income Statement,” and the period covered (for example, “For the Year Ended December 31, 2024” or “For the Month Ended March 31, 2025”). The period matters because an income statement measures activity over a span of time, not at a single point.
For a multi-step format, the structure flows like this:
- Revenue: List each revenue source and total them.
- Cost of Goods Sold: List direct costs and total them.
- Gross Profit: Revenue minus COGS.
- Operating Expenses: List each category (salaries, rent, utilities, depreciation, etc.) and total them.
- Operating Income: Gross profit minus total operating expenses.
- Non-Operating Items: List interest income, interest expense, gains, and losses separately.
- Income Before Taxes: Operating income plus or minus non-operating items.
- Income Tax Expense: The tax owed on this period’s income.
- Net Income: The bottom line.
For a single-step format, you’d simply list all revenues (including non-operating ones like interest income), then list all expenses (including COGS, operating expenses, interest expense, and taxes), and subtract total expenses from total revenues to get net income.
A Simple Example
Suppose a small retail business had $200,000 in sales revenue during the year. Cost of goods sold was $80,000, leaving gross profit of $120,000. Operating expenses included $40,000 in salaries, $18,000 in rent, $3,000 in utilities, and $2,000 in depreciation, totaling $63,000. Operating income is $57,000. The business also paid $4,000 in interest on a loan and earned $500 in interest from a savings account. Income before taxes is $53,500. After $10,700 in income tax expense, net income is $42,800.
Each of those figures came from a specific account on the adjusted trial balance. The statement simply organizes them in a way that tells a story: how much came in, what it cost to deliver, what it cost to operate, and what was left over.
Check Your Work
After building the statement, verify a few things. Every revenue and expense account from your adjusted trial balance should appear somewhere on the income statement. Your net income figure should match what flows into your retained earnings on the balance sheet. If you’re preparing financial statements for external use, the income statement, balance sheet, and cash flow statement all need to tie together, and net income is the connecting thread.
Review each line item for reasonableness. If rent expense jumped 300% from last year and you didn’t move to a bigger space, something is miscoded. If revenue dropped but COGS stayed flat, investigate whether inventory was counted correctly. These sanity checks catch classification errors and missed adjustments before anyone else sees the statement.
Picking the Right Period
Income statements can cover any time frame: a month, a quarter, or a full year. Monthly statements help you spot trends and react quickly. Quarterly statements align with tax payment schedules and investor reporting. Annual statements give the big picture. Many businesses prepare all three at different times for different audiences. The key is consistency. If you compare this January’s income statement to last January’s, you’re looking at the same length of time and the same seasonal patterns, which makes the comparison meaningful.