Business owners can gain insights about the health of their business by analyzing the financial statements. Understanding your income statement can help you run the business more efficiently. Here’s how to read an income statement for you business.
The Income Statement is also known as a Profit and Loss Statement. Income Statement uses the same account data as the Balance Sheet, but it serves a different purpose.
The first item that a business owner should focus on when learning how to read an income statement is to look at the current month’s Net Operating Income. Did company make money this month? To determine the factors of the Net Operating Income, we need to go back to the top of the Statement.
First, start with Revenue. How much sales did the company make? Were the sales more than last month? Why or why not? Did the company hit their sales goal? A business owner should be able to find an answer to all of these questions just by carefully going through the Income Statement.
Make sure that the sales are earned revenues. Examples of unearned revenue include Deferred Revenue and Customer Deposits. Deferred Revenues are revenues that have been received from customers before the customer has used the services or products the company is selling. Customer Deposits are revenues that are paid by the customer as a down payment for services or products that they will receive in the near future.
The next item on the statement would be Cost of Goods Sold. This is cost that is directly related to the revenue. The balance in Cost of Goods Sold should be going up as the sales go up. Typical items that should be classified as Cost of Goods Sold are: direct material (inventory), direct labor, merchant fees, inbound freight, etc.
Next is the Gross Profit Line and Gross Profit percentage. Business owners should be focused on the Gross Profit percentage. This is critical to help you understand the contribution your sales are making to cover SG&A. A stable or predictable GP helps us determine pricing, break even strategies, sales targets, etc.
Next is the Operating Expense. In this section, many items are fixed expenses that a business would need to operate. A few examples are rent, utilities, any administrative salaries, and insurance expense. These are essential expenses that will be steady regardless if the company produces more or less revenue. Not all expenses are fixed; there can be variable costs as well. Some of these expenses can be office supplies, meals and travel, bank fees, etc. Many times Operating Expenses are referred to as Overhead.
Lastly, once the Gross Profit is calculated and all the operating expenses are added up, the next step is Net income. This is simply Gross Profit minus Operating Expenses. This tells us whether the business is making money or not. The Income Statement provides detailed facts to why the company performed in the way it did.Written by: Adriat Markos TGG Accounting