This is a key figure for investors, creditors, and internal management because it shows how profitable the company is at selling its goods or making its products. A multi-step income statement also differs from an income statement in the way that it calculates net income. A single-step income statement includes just one calculation to arrive at net income. Multi-step income statements, on the other hand, use multiple equations to calculate net income. In doing so, they also calculate gross profit and operating income, which aren’t included on a single-step income statement.

An income statement, also called a profit and loss statement, is one of three major financial statements that all businesses should prepare as part of their financial accounting, along with a balance sheet and a cash flow statement. The multi-step income statement shows important relationships that help in analyzing how well the company is performing. For example, by deducting COGS from operating revenues, you can determine by what amount sales revenues exceed the COGS. If this margin, called gross margin, is lower than desired, a company may need to increase its selling prices and/or decrease its COGS. The classified income statement subdivides operating expenses into selling and administrative expenses. Thus, statement users can see how much expense is incurred in selling the product and how much in administering the business.

In preceding chapters, we illustrated the income statement with only two categories—revenues and expenses. In contrast, a multi-step income statement divides both revenues and expenses into operating and nonoperating (other) items. The statement also separates operating expenses into selling and administrative expenses.

This would include cost of goods sold, as well as costs such as advertising expenses, salaries and administrative expenses, including office supplies and rent. Net Income can be calculated by adding or subtracting the various non-operating expenses from operating profit. On this multi-step income statement, there is interest expense, interest income, a non-operating gain, and income tax expense. You should add the interest income and non-operating gain and subtract the interest expense and income tax expense from operating profit. The multistep income statement gives far more detail than the single step statement, but it can also be more misleading if not prepared correctly. For instance, management might shift expenses out of cost of goods sold and into operations to artificially improve their margins.

Step 1: Calculate Gross Profit

Unlike the operating section, the non-operating section is not split into subcategories. The multi-step income statement helps users in analyzing the performance of the business. Investors, lenders, and other key stakeholders monitor the gross margin of the business, which is calculated as a percentage of net sales. The gross margin is then compared to the company’s past gross margins and other comparable entities’ gross margins to determine how efficiently the company is performing. The selling and administration expenses from operating activities are captured in the second section of a multi-step income statement. The selling expenses are the costs incurred when selling goods to consumers and may include marketing expenses, the salary of sales personnel, and freight charges.

The income statement shows the total revenue attributable to the primary activities of the business, excluding revenues from non-merchandise-related sales. This sample multi-step income statement from Accounting Coach shows the layout of a multi-step income statement with the separation between operating and non-operating activities. Let us understand how to prepare multi-step income statement and how to identify the items that should be included under each head.

Operating income measures the amount of income from operations excluding all non-operating income and expenses. One of the important features of the multiple-step income statement is the sub-total for operating income. Notice that net income is the bottom line but it includes a provision for income taxes and also interest expense. A multiple-step income statement presents two important subtotals before arriving at a company’s net income. For a company that sells goods (merchandise, products) the first subtotal is the amount of gross profit.

Disadvantages of Single-Step Statements

Gross profit is used by creditors to show the company’s ability to meet arising debt obligations and to pay back outstanding credit. Small businesses with a simple operating structure, including sole-proprietorships and partnerships, can choose between creating single-step or multi-step income statements. The final step for preparing your multi-step income statement is determining your net income. This is done by subtracting other revenue and expense totals from your operating income. The easiest income statement to prepare, the single-step income statement provides an at-a-glance look at revenues and expenses, which most smaller businesses will find sufficient.

Direct costs refer to expenses for a specific item, such as a product, service, or project. Contrarily, indirect costs are generalized expenses that go towards a company’s broader infrastructure, and therefore cannot be assigned to the cost of a specific object. Examples of indirect costs include salaries, marketing efforts, research boston tax dispute attorney and development, accounting expenses, legal fees, utilities, phone service, and rent. The format of the multi-step income statement contains Non-Operating Head as the third section. The non-operating and the other head list all kinds of business incomes and expenses unrelated to a business’s principal activities.

Single-Step vs Multi-Step Income Statement: Key Differences for Small Business Accounting

The gain may be a one-time item such as a winning lawsuit or insurance settlement. The gain does not relate to the company’s core business activities, so it is listed in the non-operating section of the income statement. Going back to our retailer example, the total sales figure would include all merchandise sales made during the period and the cost of goods sold would include all expenses paid to purchase, ship, and get the merchandise ready for sale. The gross margin computes the amount of money the company profits from the sales of its merchandise. This is simply the cash flow in from the sales of merchandise and the cash flow out from the purchase of that merchandise.

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All publicly-traded companies in the U.S. must adhere to Generally Accepted Accounting Principles (GAAP), which are accounting standards nonaccrual experience method nae issued by the Financial Accounting Standards Board (FASB). Many private companies elect to follow GAAP, even though they aren’t legally obligated to do so. In any case, GAAP gives companies the option of issuing either single-step or multiple-step income statements, depending on how they’re structured. The format of the multi-step income statement contains Selling and Admin Expenses as the second section. It notes all company operating expenses in two categories that are Selling and Administrative.

Operating Profit

1. The multi-step income statement calculates gross profit, operating profit, and net income.
2. Smaller businesses may use the more simplified single-step income statement, unless otherwise required by their creditors or lenders.
3. This would include cost of goods sold, as well as costs such as advertising expenses, salaries and administrative expenses, including office supplies and rent.
4. Notice that net income is the bottom line but it includes a provision for income taxes and also interest expense.

It separates revenues and expenses from activities that are directly related to the business operations from activities that are not directly tied to the operations. A multi-step income statement is ideal for large, complex businesses that use a long list of incomes and expenses. The multi-step income statement categorizes operating and non-operating incomes and expenses.

The above are two different ways of presenting the income statement of a company. So, we get various details of the advantage of a multi-step income statement from the above points. We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. You can also include taxes in this section, or if you’re looking to create EBIT (earnings before income taxes), you can create a separate section for taxes. There are three formulas you need to use for this method of calculating net income. Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching.

Finance and accounting professionals will also use the multi-step income statement to compare between companies, as it allows for comparisons for the gross profit margin or the operating profit margin. Because of this greater detail, the multi-step income statement is often used for financial ratio analysis. The operating section is subdivided into two main sections that list the primary business income and expenses. The first section computes the gross profit of the business by subtracting the cost of goods sold from the total sales.