🤓 Let's Talk About the Income Statement!
How to review and read your income statement as a business owner
For the next few weeks, I’ll discuss reading and understanding your financial statements — Income Statement, Balance Sheet, and Cash Flow. Today’s post is on the Income Statement. What is it? How do you read it? What does it tell you about your business?
The Income Statement is also known as the Profit & Loss Statement and Statement of Activities (nonprofits). This report shows how much money (net income) you’ve made monthly as an operating business. You start reading the income statement from the top and move down. If you have the report in months or years, you read the top line first and scan to the right to see the trend, then you move down to the next line and repeat. You’re looking for something that breaks the trend you see, so you can start asking questions about what could cause this break.
If you want to be nosy 😆 to see how public companies and nonprofits operate their business, check out their statements to review. For nonprofits, search for their 990 tax form filings. Check out the SEC, Google Finance, or Yahoo Finance for public companies’ reports. The SEC database provides a more detailed report, while Google and Yahoo Finance provide a summary overview. There’s nowhere to see the reports of private companies unless you become an investor or buy the company.
There are six main sections to an income statement:
Revenue
Costs of Goods or Services
Gross Profit
Operating Expenses
Other Income or Expenses
Net Income
Revenue
This is your top-line revenue or income. Here is where all of your direct business sales will be recorded. Depending on how you want to analyze your company, this section could be grouped by product lines or locations, or all sales are grouped into one line item. This section is not the same as your net income. Revenue is usually the bigger number that business owners like to brag about. It’s important to grow it, but if you’re inefficient and careless with your expenses, you’ll always feel like you’re not making any money.
Costs of Goods or Services (COGS)
Every direct expense related to making a single sale should be recorded here. For instance, the raw materials to make the food you sell will be recorded here if you're a restaurant. You can also add the particular staff members necessary to make a sale. Consider COGS as direct expenses you need to have, or a sale won’t happen. The difference between Cost of Goods and Cost of Services is whether you’re selling a physical product or a service like a consulting business.
Usually, your inventory (things you buy to sell in the future, such as retail businesses) is usually recorded on your balance sheet as an asset. Once that particular inventory item is sold, the cost of that item is turned into COGS. This then decreases your inventory since you just sold that item! We’ll talk more about balance sheets next week.
Gross Profit
This section shows how much money you have left to pay for your operating expenses after paying for your direct or variable expenses (COGS). A high gross profit margin means you have enough money to invest in growing the company, such as hiring more staff, exploring new product ideas, or increasing marketing spend. This number is important to track and benchmark with the industry standard. Google is your best friend when determining your industry's average gross profit margin. You can ask the AI tools or talk with other business owners in the same industry.
Operating Expenses
Operating expenses are every other indirect expenses related to running your business. This is where you’ll record your selling and marketing, general and administrative, research and development, and payroll expenses. These expenses are not directly revenue-generating but are crucial to running your business.
Other Income or Expenses
Other income or expenses include income received not from the primary business operations, such as grants and interest income or expenses. You can also record your income tax expenses in this section as well. Depreciation and amortization expenses also fall under this category. Depreciation expenses are the cost of a long-term asset such as a company car or computer. Instead of expensing the total cost of the car in the first year you bought it, you can record it as an asset on your balance sheet first, then record the expense on your income statement over 5 years or the useful life of the asset.
Net Income
This is where you see if your business is making money or not. Is your income growing monthly, or are you making a loss? The amount in your net income is what you’ll use to pay for things on your balance sheet, such as your liabilities (loans), buy more assets (inventory or equipment), or take owner’s distributions or dividends.
The income statement allows you to see how profitable your business is and the efficiency of your business operations. But you can’t just look at the income statement in silo without looking at the other statements. The next report, Balance Sheet, shows you how much the company owns (assets), how much the company owes others (liabilities), and how much is left in the business (equity).
🔜 The next post will be looking at the Balance Sheet. What is it? How do you read it? What does it tell you about your business?
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😁 Disclaimer: I'm not your employee or finance consultant, so all business decisions are yours.
Woolichooks provides finance digital transformation services, which include setting up finance software systems and processes to enable companies to scale for growth.