The Difference Between Service and Manufacturing Income Statements
Businesses summarize their earnings and expenses on regularly compiled income statements. Income statements are the first financial statement that businesses prepare, providing investors and managers with important information on the profitability of the company. While every business has necessary expenses, manufacturing firms rely on converting inventory to products. Manufacturing businesses typically prepare income statements that provide more detail about expenses and revenues than do service firms.
Service businesses prepare single-step income statements. A single-step income statement discloses the firm’s profit or loss through the use of a single subtraction. Expenses are totaled together on one line and subtracted from total revenues to equal the net profit or loss. Most single-step income statements provide additional information by itemizing categories of expenses and revenues.
Multi-step income statements separate operating revenues and expenses from nonoperating revenues and expenses. Manufacturing businesses use multi-step income statements, sometimes called classified income statements, to provide investors with more detailed information about the health of their income. First, cost of goods sold is subtracted from sales revenues to determine gross profit or loss. Then, operating expenses are subtracted from gross profit to calculate operating income. Finally, nonoperating expenses and revenues are totaled up and added to or subtracted from operating income to arrive at net income.
Investors often look to income statements to assess the health of a business. Service businesses are often compared in terms of profit margin, which is the ratio of net income divided by total revenue. Manufacturing businesses, unlike service businesses, provide gross profit and operating income in addition to net income. Investors may examine return on sales, which is operating income divided by total revenue, and gross profit margin, which is the gross profit divided by total revenue, when analyzing manufacturing firms.
When preparing income statements for internal use, accountants and managers have more flexibility in how they format their statements. Many manufacturing firms prepare income statements in contribution margin format, which itemizes fixed and variable costs per product, to aid managers in setting sales mixture targets. Any income statements following a nonstandard format must be appropriately labeled and kept away from public access.