Multi-Step Income Statement

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A multi-step income statement classifies the revenues, expenses, losses, and gains into operating and non-operating sections (commonly known as heads).

It’s an alternative to the single-step income statement that allows users of the statement to better determine the profitability of the company and how much of it is contributed by the core operations.

As an example, let’s suppose a clothing manufacturing company has an overall net profit for a year. However, looking into the breakdown as provided by a multi-step income statement, the investor or creditor can see that the company is not doing so well on its core business operations. In fact, the business has made an operating loss for the year. The net income becomes diluted because the company has made a gain from selling real estate and recording it as non-operating revenue.

Being able to break the income statement up into segments provides more insight into what is really going on with the company and is a core attribute of the multi-step income statement.

Multi-Step Income Statement Template

Throughout this series on financial statements, you can download the Excel template below for free to see how Bob’s Donut Shoppe uses the multi-step income statement (and others) to evaluate the performance of his business.

Components of a Multi-Step Income Statement

This consists of three key components:

Gross Profit

The gross profit is calculated by deducting the cost of good sold from total revenue. The gross profit relates to the core activity of a business and shows how profitable is a company in manufacturing its product. No other expenses are included at this point. Gross profit is a simple way of studying a business model for a company.

Investors will use the gross profit margins to determine how profitable is the business model of the company. Creditors will use gross profit to judge the general health of the company and whether it is able to pay back its obligations on time and as agreed upon.

The formula is given below:

Gross\: Profit = Net\: Sales - \text{Cost of Goods Sold}

Selling and General Admin Expenses

The selling expenses are the costs that a company incurs for selling its product or services to the customer. These include freight charges, sales personnel salaries, marketing expenses, etc. that are directly attributable to the sale.

Administrative expenses are the most general expenses and they can not be attributed to the sale of goods directly, but they are still part of the core operations. These expenses can include wages of admin staff, factory and warehouse rent, utilities, etc.

The total operating expenses are a combination of both selling and admin expenses. These total expenses can then be subtracted from gross profit to arrive at the operating income.

The formula is given below:

Operating\: Income = Gross\: Profit - Total\: Operating\: Expenses

Non-Operating Items

The two components explained above relate directly to the operations of the company. The third component of the non-operating head consists of all those revenue and expense items that do not contribute in any way to the core operations of a business.

For an expense or income to be called a non-operating activity, it should be an extraordinary item that is not part of the company’s operations. Examples of a non-operating income include gain from the sale of an asset, gain incurred in foreign exchange dealings, dividend income and profit from investments.

An example of a non-operating expense is a lawsuit claim paid by the company. The sum of non-operating incomes and expenses is called ‘non-operating item’.

The formula to calculate the net income is:

Net\: Income = Operating\: Income + \text{Non-Operating Items}

Advantages of a Multi-Step Income Statement

There are numerous benefits of using a multi-step income statement. Some of these a

  • Offers greater detail to a user or stakeholder.
  • Assists in better analyzing the financial performance and the general health of a company.
  • Investors, creditors, and other stakeholders of interest monitor the gross margin (gross profit divided by revenue) to analyze how efficient a company’s operations are.
  • Extra-ordinary items are isolated and shown under the ‘non-operating items’ head to suggest that they are one-off events and will not recur every period. Thus, a stock analyst can ignore them while valuing a business entity for a potential merger and acquisition scenario.

Single Step vs Multi Step Income Statement

The key differences that are important to note are:

  • A single step income statement uses only one step to calculate the net income, i.e. subtract expenses from revenues. Whereas, a multi-step statement uses numerous steps to arrive at the final net income figure
  • A single-step income statement shows only net income, whereas a multi-step income statement shows gross profit in addition to net income.
  • A single-step income statement is generally used in a services industry. A multi-step statement is used for manufacturing businesses.
  • Single-step statements are known to be concise and lacking details. A multi-step statement is more comprehensive.
  • A single-step income statement treats the cost of goods sold as expenses. This is not the case in a multi-step income statement.

Types of Businesses using Multi-Step Statements

Often smaller companies will choose to use a single-step income statement due to its ease and simplicity. However, for larger public organizations a multi-step format is the most desirable due to it being more comprehensive and the fact that they are under greater scrutiny from regulator and auditors to do so as well.

Even most larger privately owned businesses would need to create a multi-step income statement due to requirements from their banks and creditor who have loaned them lines of credit and would like to know in more detail the financial performance and health of the company.

Multi-Step Income Statement Example

Although Bob and his donut shop are still a small business and would not have otherwise been required to create a multi-step statement, he wants to take out a bank loan of $25,000. The bank has requested that Bob must present the income statement in a multi-step format to get a better picture of his business.

Below is an example of Bob’s multi-step income statement: