9. The Multistep Income Statement

Let's talk about the multi-step income statement. So if there's a multi-step, there must also be a single step, 'cause those two are kinda opposite, so why would we have to differentiate if there was no single step? And there is. So the single step is pretty simple. You take your revenues minus your expenses in a single step, and you get net income. This is probably what you're used to seeing, revenues minus expenses is net income, and it's still super true, but the multi-step income statement is actually quite a bit more useful. So the multi-step, what we're gonna do is we're gonna break it down into little groups.

We're gonna have revenues minus expenses, revenues minus expenses, revenues minus expenses, and then at the bottom, we're gonna add all these up, and we're gonna get our net income. So let's take a look at the multi-step. Multi-step always starts with sales. So you always have your sales revenue at the top. Let's call it $1,000.

So right away, we're gonna start with sales revenue, and then what we're gonna do is we're gonna take out cost of goods sold. So we sold something, and we sold $1,000 worth. But to produce that $1,000 worth of sales, to actually make the thing, it cost us $600. And so what this does is this gives us our gross profit.

So before we even talk about, like, running our business, you know, paying salaries, wages, advertising, any of that, we know that our gross profit is $400. So from selling the widgets and making the widgets, we now have $400 to carry us all the way down to the bottom line. So this is the first step in the multi-step. You talk about sales revenue, and you talk about the cost of the goods that you actually sold. These two always go together. And then after that, you've got operating expenses. And obviously, these are expenses of operating your business. So you can think of these as, like, advertising, salaries, depreciation, insurance, supplies.

Anything needed to actually operate your business, we're gonna put in this big section here. And we split this big section up into even smaller sections. We say one section is selling expenses, and the other section is general and admin. So you'll see this as G&A expenses.

And so now you gotta figure out, well, what kinda stuff goes into either, you know... How am I supposed to know what goes into these? And they'll be pretty straightforward on your test, but there are a couple things that are tricky. So if you see depreciation, or if you see salaries or wages, these are the two that might trip you up because these could be selling expenses, or they could just be overhead. It could be general and administrative expenses. So here's how you tell the difference. If you see depreciation, what you're looking for is depreciation on store. So it could be depreciation on store furniture, store fixtures.

It could be depreciation on the actual store building. Anything that's depreciation on the store is a selling expense, so you could see that here. Because where are you selling your stuff? You're selling it in the store, and so depreciation on anything in the store is a selling expense because you need all that stuff to sell. So if you don't see the word store, it says something like depreciation on buildings, and it doesn't say on the store, or depreciation on trademark or any intangible assets, that goes down here.

Depreciation on just buildings, it's just super unclear, then put that one down here. Now, when you see salaries and wages, you basically do the same thing. You decide, are these salaries and wages directly related to selling?

And these are going to be pretty straightforward too. You're gonna see something like sales salaries. Well, obviously that is gonna go here. Now, if you see, like, HR salaries or payroll salaries, like the people who run payroll, those are general and administrative. They're not directly related to selling your widgets. So if you see sales salaries, those are your salespeople out there trying to get people to buy your widgets, and so that is a selling expense. So that's step two. That's your second step, is your operating expenses. And so you sum all of these up. You have total selling expenses. I didn't leave enough room. Total selling expenses are something.

Total general and administrative expenses are something. Total operating expenses, so you add up all of these. So these are your operating expenses, so you subtotal them over here, and then you add them all up, and let's say your total operating expenses come out to be, we'll just say $200. And then you have your total income from operations. And what that is, is that's your gross profit up here, gross profit minus all your operating expenses.

So now you're down to $200. So you had $400 of gross profit. You operated your business, and that took a lot of money. That took $200. So we take $400 less the $200 of operating expenses, and now we have total income from operations of $200. This is a really important number for companies to know. They need to know from our actual operations, are we making money? Are we making enough money? Are we losing money? 'Cause if you're not making money, if you're not making income from your operations, like, your operations is what your business does. So if you're not making money from that, you're doing something wrong because then we go down to the third step, and the third step is...

What was the second step? Operating expenses, so the third step must be non-operating, and we generally call those other. Real catchy, other expenses, and that's stuff that didn't come directly from your operations. So that's like interest revenue, money you made on the money you had in the bank, or interest expense, money you had to pay for loans. So we put those here. That sums out to some small number. It's generally not very much, so we'll just say, uh, $20. Say that's a $20 expense, and so now we have another number. Now we're down to $180, and this one is called income before taxes.

So just like step two told us what step three was gonna be, operating expenses, well, okay, well, that leaves non-operating. This income before taxes tells us what's next, taxes. Take out some amount and just make up a number here. We'll just say $50 in taxes, and now we have our net income.

This is our final number. $130 is our net income. Let's call this tax expense just so we're clear about that. So you have income before taxes. Then you take out taxes, and you're left with net income. Okay. That was a lot of stuff, so let's take a look back. I'm gonna zoom out a little bit, take a look over the whole thing. So we started by saying we're gonna talk about the multi-step income statement. Well, multi leads us to believe that there's a non-multi or single, and we said, yeah, single is you just do it in one step. You take your revenues, subtract your expenses.

You get your net income. You're good. Go home. Multi-step, we have to do that a bunch of times. We take some revenues, some expenses, some other revenues, some other expenses, maybe just some expenses. Do a bunch of subtotals, and then finally, after much work, we get to the net income.

Starting from the top, you have your sales revenue. This is your top-line number. Sales revenue always goes at the top. Then you take out, well, how much money did we spend producing the things that we sold? That's your cost of the goods sold. Then you end up with your gross profit, and this number tells you how much money you made before you spent any money at all operating your business, how much you made on just selling your widgets. And then the next question we wanna answer is, okay, if this is how much money we made before we actually operated our business, how much money did we make operating our business?

So you take your operating expenses, and we split those up between selling and non-selling, and we call the non-selling, you know, general and administrative, you know, whatever, basically. So we take our selling, add 'em up, take our general and admin expenses, add 'em up, and they came out to be $200, right? So we take our gross profit, take out all of our operating expenses, and we're left with total income from operations. Now, this is an important number for businesses to look at and see how much money are we making operating our business. We may have some things outside of operations that come up, but really, the important number is are we making money from actually running our business?

So then we moved on to non-operating, which we decided to just call other. We have interest revenue, interest expense. These are likely, mm, probably gonna be the only ones you see. You could also have, like, lawsuits down here, anything that's not from actually operating your business. We take that out, and you're left with income before taxes. Then we take our tax expense, and you're left with your net income. Okay, I wanna show you a cleaner and prettier version of what we've just done here.

And this is what a real multi-step income statement looks like. You've got your sales and your cost of goods sold at the top leading to gross profit, which you put all the way out there. So you can see this is broken up into step one. Step two is operating expenses, and we're gonna split those out into selling and general and admin. You add those together, and that gives you your total operating expenses. You take your gross profit. You subtract out your total operating expenses, and that leaves you with your income from operations. Then at the bottom you've got step three, which is other or non-operating.

Add those up. You're left with excess of expenses, so we know that this one is an expense 'cause we had more interest expense than we had interest revenue. So we're gonna take it out. So we're gonna subtract it, and you're left with income before income taxes. Then in step four, you take out your income tax expense, and you're left with your net income. This is what a real multi-step income statement looks like. It's not different than what we did earlier. It's just a lot prettier.