How To Make An Income Statement For Freelancers & Agencies

“How much money am I making?” – This is arguably the single most important question in business. And in order to properly answer that, you need to be able to create an income statement.

But how do you actually do that?

Odds are, if you are running a freelance or small agency business, no one sat down and gave you an answer to that question. I would like to take this opportunity to correct that. In this article, I’ll show you how to create an income statement and explain how to read one.

Just a quick note here – I’m assuming that you are running a freelance or small agency operation in the US. That means you are probably a sole proprietor or single-member LLC. If you’re not, though, you’re welcome to stick around – you’ll probably still find what I’ve written below to be useful context.

What is an Income Statement, or Profit & Loss Statement?

An income statement is a financial report detailing your company’s total revenue, expenses, and profitability. It begins with the “top line,” representing total revenue, followed by expenses. The difference between the two is your net operating income.

You might also know income statements by another name – the most common of which is the profit and loss statement (P&L). But this common financial statement, believe it or not, has at least 10 commonly used names according to Wikipedia.

Wikipedia has way too many names for the same thing
Get it together, Wikipedia.

You’ll often hear the term “income statement” used in the same breath as “cash flow statement” or “balance sheet.” These are commonly regarded as the three most important financial statements a business can have. Cash flow statements show cash inflows and outflows – where money comes from and where it goes. Balance sheets show assets and liabilities – who you owe and who owes you.

Many people who have turned their side hustles into their main hustles struggle with the transition. This is owed at least partly to the fact that they no longer have pay stubs like one would get from an hourly or salaried position. Combine that with the inherent variability of freelance and agency earnings, that means to succeed financially, you really need to understand your income statement.

Your net operating income is roughly the equivalent of your gross pay at a day job. That means your income statement is roughly equivalent to your pay stub.

1. Prepare your financial records.

Before you can create an income statement, you will need to have clean, accurate financial records. That’s a big task in its own right if you’ve never had to do it before. If your financial records are not accurate enough to run a report  I recommend you read through this guide on how to best way to keep track of small business finances first.

In order to proceed from here, you will need to have all of your revenues and expenses for a certain period of time documented. If you want to create an income statement for the year-to-date and it’s March 15, you want to have all your revenues and expenses ready from January 1 onward.

2. Create your income statement.

Once you have clean financial records, putting together an income statement is not nearly as hard as it sounds. In fact, if you have accounting software set up, you can probably run a standard report with the click of a button. I use QuickBooks for my agency, for example, and all I have to do is click on the standard Profit & Loss report option.

Quickbooks screenshot

This is what it looks like for me, though it may be different for you even if you use QuickBooks.

Even if you’re still tracking everything in an Excel sheet, though, you can still put together a Profit & Loss statement with a pivot table or even by summing your revenue and expenses by hand. The transition from understanding the concepts to applying them is small.

2.1. Calculate income, or revenue.

Revenue represents the total income earned from business activities before any deductions. It includes sales of goods, services provided, or any other primary income sources. Accurately calculating revenue is super important here because it’s the “top line” of your income statement.

Basically, any money you or members of your team bring in through consulting, coaching, freelance work of any sort, and so on would count as revenue.

Income statement top section

2.2. Deduct cost of goods sold (COGS), if applicable.

If you produce physical products, you will also need to deduct cost of goods sold (COGS). The idea of cost of goods is that you take out the direct costs associated with producing the goods from income. This might include materials and labor.

If you have COGS, your revenue section of the income statement will look something like: Total Income – COGS = Gross Profit.

But if you are a freelancer or running a small agency, COGS may not be relevant, since your services likely don’t involve physical products. Even if you are paying others, that will likely qualify as a payroll expense, which would show up under Expenses.

2.3. Calculate gross profit.

Gross profit is your revenue minus your cost of goods sold (COGS). When your gross profit differs from your revenue, this can tell you how efficiently you are producing or delivering services. You can see, by the difference between gross profit and revenue, if you are paying too much in overhead expenses.

Back when I made board games, I did have a COGS and my gross profit substantially differed from revenues. For my marketing agency, though, gross profit and total income (aka. revenue) are one and the same.

2.4. Separate operating expenses and other expenses.

This is not a normal part of the process, but I’ll tell you about it anyway, because I find it very helpful. This wisdom doesn’t come from me, but rather I’m passing it to you from my accountant.

This will help you file your annual taxes and compare your business earnings to something you already have experience with – a normal day job paycheck.

In pursuit of these two goals, we have chosen to separate expenses (operating expenses) from “other expenses”. This is because, like a lot of people, I’m running a single-member LLC. Below is an example of what I mean, with the real numbers replaced by fake ones.

Separating expenses

The reason for this is technical, but important, so bear with me!

If you run a sole proprietorship or single-member LLC, that means you have to file an annual 1040 form and Schedule C with the IRS. The Schedule C needs to show your business income and expenses. Your 1040 needs to show your personal income and expenses.

I pay for my taxes, health insurance, and retirement out of the company bank account because I consider my company my employer and these are the sorts of things employers pay for. However, the IRS sees it differently, so we categorize them as “Other Expenses.”

(Funnily enough, though, the health insurance and retirement are still tax deductible – I just have to report it on the 1040 and not the Schedule C, which I just find plain weird.)

3 benefits to separating operating expenses and other expenses

If you go through the exercise of separating “operating expenses” from “other expenses”, you benefit in three ways:

  1. You can see the difference between your net operating income (“gross pay”) and your net income (“take-home pay”).
  2. You can see your “deductions” for your “benefits” which would include things like retirement and healthcare, as well as your “withholding” for your taxes (the amount you set aside for quarterly filing).
  3. When it’s tax time, you can look at operating expenses, and put that on your Schedule C. You can look at other expenses, and put that on your 1040. And you don’t have to worry about sorting them out in the moment while Uncle Sam sweatily breathes over your shoulder on a pollen-soaked mid-April afternoon. 

To put it more plainly, this is the best way I know to be able to translate your business success to something you likely understand more intuitively – a paycheck.

2.5. Subtract operating expenses.

Operating expenses include all costs required to run the business that are not directly linked to product creation or service delivery. Examples would include ads and marketing, office supplies, software subscriptions, and payroll expenses. 

Calculating expenses

Subtracting these from gross profit will help you tell how much money you’re actually making.

2.6. Calculate net operating income.

Net operating income is the profit remaining after all operating expenses are deducted from gross profit. The resulting number is comparable to your gross pay or a salary at a more traditional job.

That means it does not account for taxes, interest, or other expenses.

Calculating NOI

2.7. Calculate taxes and other expenses.

At this step, you will subtract taxes and any other non-operating expenses from the net operating income. Any money you set aside for quarterly tax filing would count, as well as any interest payments on loans.

Quick note – if you have a checking or savings account that provides you with interest income, I recommend classifying that under Other Income. That’s why this screenshot appears the way it does.

Other expenses here can include “benefits” which can be deducted from your taxes but not your business taxes, such as retirement contributions and health insurance.

2.8 Calculate net income.

Net income, the bottom line, is the total profit after all expenses, including taxes and interest, have been deducted from revenue. In short, this is your profit. This is your take-home pay!

Full Income Statement

Quick Note: I’ve skipped depreciation and amortization.

Depreciation applies to physical, long-term assets like machinery, vehicles, and buildings. It spreads the cost of these assets over the years they are expected to be used. Amortization is a similar concept, but for intangible assets like patents, trademarks, and software.

I decided to skip these two concepts since they don’t come up very often for freelancers or small agencies, particularly if you work from home.

3. Review your income statement.

Once you create an income statement, whether by using software or by manual tallying of numbers, it’s a good idea to slow down before taking a look at it. That way, you can really process what all the numbers mean in a practical sense.

Some questions you should ask yourself include:

  1. At the end of the day, am I taking home the amount of money I want to, in terms of net income?
  2. How much am I spending on “other expenses” such as taxes, health insurance, and retirement? Am I OK with those numbers?
  3. Does the net operating income suggest that operating expenses are too high?
  4. Either way, are there operating expenses that I can cut?
  5. Is the company bringing in enough revenue?

Your income statement gives you the perfect chance to ask these kinds of specific questions. Then, from your answers to those questions, you can come up with concrete goals to fix tangible issues. 

4. Standardize your processes for easy maintenance.

If you plan to run income statements on a regular basis and don’t have accounting software set up, I strongly recommend you do that. Every accountant uses QuickBooks. FreshBooks and Xero are also good options.

Once you do that, get into the habit of tracking your business expenses and revenues on a regular basis. Then you can run reports like this in less than a minute and with only a few clicks.

Final Thoughts

When you got into freelance or agency work, there is a good chance you left behind a traditional job. And that can leave you wondering what to make of your financial situation, since you no longer have paychecks to refer to. 

Your income statement is the next closest thing to a traditional paycheck. It’s your best answer to that question that has plagued all businesses since time immemorial: “how much money are we making?”

Frequently Asked Questions

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