You didn’t start your business to become an accountant. You started it to do what you love and make a living out of it. However, just like the “Terms and Conditions” we often ignore but shouldn’t, understanding income statements is one of those non-negotiables in your entrepreneurial journey.
So what does an income statement show? An income statement shows a company’s revenues, costs, and expenses over a certain period. It provides a clear, quantified summary of how your business is performing financially. It displays your revenue (or sales), the cost of the goods or services sold (COGS), gross profit, operating expenses, operating income, and net income.
What Does an Income Statement Show?
An income statement, often called a profit and loss statement (P&L), is a financial document that reveals how your business is performing over a specific period, showing whether you’ve turned a profit or suffered a loss. Let’s break down the key components:
1. Revenue
Revenue, or sales, is the money you bring in from selling your goods or services. This is the top line, the one that makes you feel like you’re a billionaire when the figures are high. Remember: High revenues are only part of the story.
2. Cost of Goods Sold (COGS)
This one’s the money you spend to produce the goods or services you sell. So if you’re a retailer, it’s what you paid for the goods you’re selling. If you’re a manufacturer, it’s the cost of materials and labour to make your product.
3. Gross Profit
Now, subtract the COGS from your revenue, and you get the gross profit. It’s a simple, honest measure of the profitability of your products or services.
4. Operating Expenses
This is where it can sting. These are your day-to-day costs (e.g., salaries, rent, marketing, utilities, and depreciation of assets). It’s all the stuff you need to keep the doors open and lights on.
5. Operating Income
Take your gross profit and deduct your operating expenses – that’s your operating income. It’s a truer measure of your business’ health because it reflects the costs of doing business.
6. Net Income
This is what’s left after all the costs, taxes, and interest payments are subtracted from your operating income.
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Pro tip
An income statement is basically your business' report card. It tells you whether or not you’re doing a good job in terms of financial management.
Importance of Analysing Income Statements for Financial Management
First and foremost, income statements aren’t just for bankers or investors. Another metaphor for income statements is that they’re the pulse of your business, reflecting the state of your brand’s financial health. By regularly analysing your income statement, you can identify profitability patterns, track expenses, and recognise growth trends or potential pitfalls.
Secondly, a detailed understanding of your income statement enables you to benchmark your business’ performance against past performance, or even against competitors. By doing this, you can set realistic financial goals and measure progress over time.
Thirdly, income statements provide a window into the operations of your business, not from a subjective point of view, but objectively, in black and white. They help you make fact-based decisions. For example, an increase in operating expenses might indicate inefficiencies that need addressing, while consistent growth in revenues could suggest the right time to scale up your business.
Example
Suppose you run a coffee shop. Over the years, you’ve seen steady growth in revenues. Sounds good, right? But your net income isn’t following the same upward trend. Without analysing your income statement, you might be left scratching your head, wondering why you’re not reaping the benefits of your booming business.
Let’s take a look at the income statement. Your COGS, the cost of the coffee, pastries, milk, and so forth, is relatively stable. But your operating expenses have been increasing, and on closer examination, you find that your rent and staff costs have been creeping up every year.
Without an income statement analysis, you wouldn’t have identified the root cause. Now you have a clear view of what’s happening and can strategize accordingly. Maybe it’s time to renegotiate your lease, or perhaps you need to adjust your staffing model.
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Let Us Guide You Through Your Income Statement Preparation Process
Knowing how to read an income statement is one thing, preparing it is another. It’s like knowing how to read a map versus drawing one.
That’s where we come in. At The Bookkeeping Studio, we’re not just number-crunchers. We’ll help you navigate your financial management journey by providing you with accurate and timely information. Based in Australia, we’re a team of experts who understand that behind every number on your income statement is a decision, a strategy, an action that impacts your business. Understand what your business is trying to tell you today.
