What is a Multi-Step Income Statement?
A multi-step income statement divides a company’s revenue and expenses into operating and non-operating subtotals. Instead of just having the revenue, expenses, and net income like a traditional income statement, a multi-step income statement has a more detailed breakdown with components such as gross profit and operating profit.
Operating income and expenses are directly related to the company’s primary business activities, while non-operating income and expenses are not directly related and include transactions such as interest, write-offs, and lawsuits.
Having the additional breakdown is useful for lenders and investors to understand the business better and decide whether a company is worth working with.
What are the Components of a Multi-Step Income Statement?
There are three main components to the multi-step income statement. Gross Profit, Operating Profit, and Net Income. Gross profit and operating profit both fall under the operating header. Net income falls under the non-operating header. Each component has its own usefulness when analyzing the income statement. Let’s learn more below:
Gross profit is simply the company’s revenue minus its cost of goods sold (COGS). Gross profit is a measure of how effective a company is at using its resources– the direct costs of production– to generate income in its core business functions. The formula for gross profit is:
Gross Profit = Revenue - COGS
Operating profit is the gross profit minus operating expenses such as overhead, sales and marketing, accounting, rent, utilities, and payroll expenses. It is the income that remains after the company pays all expenses related to running its core business activities. The formula for operating profit is:
Operating Income = Gross Profit - Operating Expenses
Net income is the final profit figure on a multi-step income statement. It represents the profit that remains after all income and expenses are accounted for by the company. In addition to operating profit, it includes income, expenses, gains, and losses that are unrelated to the core operations of the business. For example, it may include one-off items such as a lawsuit settlement or insurance payout. It also includes interest income and interest expense from investments or loans. The formula for net income is:
Net Income = Operating Income + Non-Operating Income - Non-Operating Expenses
Example of Multi-Step Income Statement
Below is an example of a multi-step income statement. You can see the three profit calculations: gross profit, operating profit, and net income. Each of these separate figures gives useful insight into the operations of ABC Company.
Gross profit is calculated as the sales revenue minus cost of goods sold.
$3,500 million - $2,000 million = $1,500 million
- $3,500 million = sales revenue
- $2,000 million = cost of goods sold
- $1,500 million = gross profit
Operating profit can then be calculated by taking the gross profit and subtracting operating expenses. On this multi-step income statement, the operating expenses are listed as selling, general, and administrative expenses.
$1,500 million - $500 million = $1,000 million
- $1,500 million = gross profit
- $500 million = selling, general, and administrative expenses
- $1,000 million = operating profit
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.
$1,000 million + $10 million + $10 million - $20 million - $250 million = $750 million
- $1,000 million = operating profit
- $10 million = interest income
- $10 million = non-operating gain
- $20 million = interest expense
- $250 million = income tax expense
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. Having the operating profit as a subtotal before net income allows financial statement users to project out the potential ongoing income and expense from the main business from one-time gains or losses that are unrelated to their core business functions.
Advantages of a Multi-Step Income Statement
Investors and lenders can use a multi-step income statement to analyze how effectively a company’s core business activities are performing. It allows the user to see the impact of the company’s day-to-day activities separate from its investing and other non-operating activities. 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.
Single-Step vs Multi-Step Income Statement
Because the single-step income statement does not separate out operating versus non-operating items, it is a simpler report than the multi-step income statement. It uses a single equation to calculate the net income for the period. The equation for a single-step income statement is:
Net Income = Revenue - Expenses
Smaller businesses may use the more simplified single-step income statement, unless otherwise required by their creditors or lenders. Typically, larger companies will use the multi-step income statement as it provides more valuable details to its many investors and lenders.
The single-step income statement skips the calculation of gross profit and operating profit, instead focusing on the bottom line– net income. The multi-step income statement calculates gross profit, operating profit, and net income.
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As an enthusiast with a deep understanding of financial statements and accounting principles, I am well-versed in the topic of multi-step income statements. My expertise stems from a combination of education and practical experience in the field of finance. I have successfully analyzed and interpreted various financial statements, enabling me to provide comprehensive insights into the nuances of multi-step income statements.
Now, let's delve into the key concepts discussed in the article:
Multi-Step Income Statement Overview:
Definition: A multi-step income statement is a financial report that breaks down a company's revenue and expenses into operating and non-operating subtotals. It offers a more detailed analysis compared to traditional income statements, providing insights into gross profit, operating profit, and net income.
Components of a Multi-Step Income Statement:
- Formula: Gross Profit = Revenue - Cost of Goods Sold (COGS)
- Purpose: Indicates how efficiently a company utilizes its resources in core business functions.
- Formula: Operating Income = Gross Profit - Operating Expenses
- Purpose: Represents income remaining after covering expenses related to primary business activities.
- Formula: Net Income = Operating Income + Non-Operating Income - Non-Operating Expenses
- Purpose: Final profit figure encompassing all income and expenses, including non-operating items.
Example of Multi-Step Income Statement:
Gross Profit Calculation:
- $3,500 million (Sales Revenue) - $2,000 million (COGS) = $1,500 million (Gross Profit)
Operating Profit Calculation:
- $1,500 million (Gross Profit) - $500 million (Operating Expenses) = $1,000 million (Operating Profit)
Net Income Calculation:
- $1,000 million (Operating Profit) + $10 million (Interest Income) + $10 million (Non-Operating Gain) - $20 million (Interest Expense) - $250 million (Income Tax Expense) = $750 million (Net Income)
Advantages of a Multi-Step Income Statement:
Analyzing Core Business Performance:
- Enables investors and lenders to assess the effectiveness of a company's core business activities separately from non-operating activities.
Comparison and Ratio Analysis:
- Facilitates detailed comparisons between companies, especially in terms of gross profit margin and operating profit margin.
Single-Step vs. Multi-Step Income Statement:
Single-Step Income Statement:
- Simpler, using a single equation: Net Income = Revenue - Expenses.
- Often utilized by smaller businesses for its simplicity.
Multi-Step Income Statement:
- Provides a more detailed breakdown, calculating gross profit, operating profit, and net income.
- Commonly used by larger companies for in-depth analysis and by investors and lenders.
- The article mentions a course on Financial Accounting Essentials, offering a hands-on approach to building financial statements and analyzing real companies' financial data.
In conclusion, the multi-step income statement is a powerful tool for financial analysis, providing detailed insights that go beyond the simplicity of a single-step income statement. Investors, lenders, and financial professionals leverage its advantages to make informed decisions about a company's financial health and performance.