A multi-step income statement is a format that businesses use to report their profits.
Publicly-traded companies have the obligation to define their gross profit and operating expenses and revenue from other sources. This is basically the reason they need to calculate the multi-step format of income statements.
Also, it lists items in different categories to make it convenient for users of the income statement to better understand the core operations of the business.
Additionally, companies with many income sources can only capture all transactions when this income statement is prepared.
Stay with us as we explain how to calculate the multi-step income statement and give the formula needed to calculate it.
What is a Multi-Step Income Statement?
A multi-step income statement reports a company’s revenues, expenses, and overall profit or loss for a specific period. It can otherwise be called a multi-step profit-and-loss statement.
It offers an in-depth analysis of a business’s financial performance.
The format of a multi-step income statement is such that separates a company’s operating revenue and expenses from its non-operating revenue and expenses.
This differentiation gives an insight into how a company’s primary business activities generate income and affect costs as opposed to performing other activities.
Apparently, a Multi-step income statement uses multiple equations to calculate net income. This enables it to calculate gross profit and operating income.
What are the Components of a Multi-Step Income Statement?
The key components of a multi-step income statement are:
1. Operating Head – Gross Profit
Gross profit is in the first section of a multi-step income statement. It is gotten from deducting Cost of Goods Sold from Total Sales.
That is; Total Sales/Net Sales – Cost of Goods Sold.
In this calculation above, no other expenditures are included apart from the cash inflow from the sale of goods and cash outflow from the purchase of goods.
Actually, Gross profit shows how profitable a company is either in manufacturing or selling its products.
Creditors of a company use this variable to determine if a company can meet its financial obligations and repay outstanding credit as the need arise.
Likewise, investors also use gross profit to determine the profitability of a business and the general health of the company.
2. Operating Head – Selling and Admin Expenses
This is the second section of multi-step income statement.
Actually, selling and administration expenses from operating activities are captured here. Selling expenses encompass all costs incurred when selling goods to consumers. This includes distributing, marketing, and selling expenses for the product or service.
Also, Administrative expenses are those expenses an organization incurs that are not directly tied to a specific function but related to the organization. This includes salaries of personnel, office rent, etc.
The total operating expenses are gotten by adding the selling expenses and administrative expenses. It is calculated as follows:
Operating Income = Gross Profit – Operating Expenses
3. Non-Operating Head
The third section is the non-operating head.
This section lists all business incomes and expenses that are not related to the main activities of the business.
Before an item can be classified as either an operating income or expense, it has to be from a source that is not part of the company’s main/ordinary business.
For example, a non-operating expense can be a lawsuit claim paid by a business to an aggrieved customer. Another example is the insurance compensation a company receives for damages to an asset.
Therefore, to calculate the non-operating head, you sum up all the items that fall under this category. Thus, it is:
Net Income = Operating Income + Non-Operating Items
Which Type of Business Use the Multi Step Income Statement?
This accounting system is ideal for large, complex businesses that have a long list of incomes and expenses.
In addition, public companies need to prepare for this because of regulatory authorities. It helps to differentiate the financial report from primary and non-primary business activities.
For instance, manufacturing companies that have multiple sources of revenue should prepare a multi-step income statement so that the incomes and expenses from primary business activities are differentiated from non-primary activities.
How Does Multi Step Income Statement Preparation Work?
Did we already mention that there is a single-step income statement? A single-step income statement provides a simple financial report, it does not include gross profit and operating income.
The multi-step income statement is the more complex form of capturing all financial transactions.
Here are the steps you need to follow to create a multiple-step income statement for your business.
1. Select a Reporting Period
You need to start a reporting period before you can prepare an income statement.
Typically, income statements are prepared monthly, quarterly, or annually. Public companies prepare both quarterly and annually as part of their legal obligations.
An advantage of preparing income statements monthly is that it helps you track how profits change over time, this is invaluable information for decision making.
2. Create a Document Header
The header of your multi-step income statement conveys important information to readers.
Basically, it states the name of your company, identifies the document as an income statement, and defines the reporting period covered by the document.
3. Add Operating Revenues
Total Operating activities are in the top section.
To calculate this, first, add your operating revenue/income. This is the sales revenue from selling your goods and services.
4. Add Operating Expenses
After adding the operating income, next up is to add the operating expenses.
This includes cost of goods sold, and other costs such as advertising expenses, salaries, administrative expenses, as well as office supplies and rent.
5. Calculate Gross Profit
Calculate Gross profit by subtracting cost of goods sold from net sales.
Title the figure Gross Profit.
6. Calculate Operating Income
The next item on the multi-step income statement is to calculate operating income.
Subtract Operating expenses from gross profit to get the operating income.
At the bottom of the operating activities, add the title Net Operating Income or Income from Operations with the figure gotten from the calculation.
7. Add Non-Operating Revenues and Expenses
Below the operating activities comes another section non-operating activities. Here, you add revenues and expenses from non-operating activities, including interest and the sale or purchase of investments.
8. Calculate Net Income
The final step in drafting an income statement is calculating net income.
To do so, add the operating income and non-operating items and title as Net Income.
If it is a positive number, you have a profit. If negative, you’re recording a loss.
Here is an example of calculating a multi-step income statement:
The multi-step income statement is an alternative to the single-step income statement because it uses multiple subtractions in computing the net income.
Lastly, it differentiates operating revenues and expenses from the non-operating revenues and expenses, gains, and losses.
Companies with complex financial systems need to use this in order to capture all transactions in the income statement.