In my last blog, we discussed the importance of a Balance Sheet and how to read it. Now we will highlight the Income Statement. A Balance Sheet tests the health of the business, and the Income Statement will observe the “diet,” or performance, of the business. For example, if the Balance Sheet is showing that the business is not doing well, the income statement will provide the explanation as to why. The Income Statement will show what the revenue is and where money is being spent.
The Income Statement will always start with Revenue. This shows how much the business has sold of its products/services. The next line item would be Cost of Goods Sold. This will include all the costs that were directly related to the process of generating the revenue. Subtracting the two from each other will result in Gross Profit. Gross Profit should be a positive number, unless you are selling your product for less than it costs to produce it!
The next items will be Operating Expenses. This will include everything from sales and marketing to office rent. This category includes all the monthly fixed or administrative fees. What is meant by fixed fees is usually anything that a business owner would have to pay regardless of how much revenue they generate on a monthly basis. Now take the Gross Profit and subtract it from operating expenses. This will provide a Net Operating Income. Net Income represents the profit generated during a specific time period that the business has generated. If Net Income is negative, this means that the expenses of the business are more than the generated sales. Again if the business is not looking at the income statement, he/she will have no idea that they are losing money despite their great sales.
Keep in mind that these two pieces of paper, Balance Sheet & Income Statement, can be the difference of staying in business and being profitable, or losing money and going out of business. TGG can help you understand these basic business tools and help you manage your business more effectively.Written by: Adriat Markos TGG Accounting