How to Read Your Income Statement

The income statement of any business is probably the most important report of all. It is a snapshot of the financial performance of a business over a period of time, such as a month or year. It is also called the Profit and Loss Statement (P&L) and provides business owners with an enormous about of data if they know where to look and how to read it

Let the Lucrum Consulting team explain the report, step by step.

First things first, the P&L is a “period” report. This means it only covers activity from one date to another. This date call be all of today, last week, last month, last year, or this month, this quarter, etc. Any transaction outside of that period won’t be reflected. Second, it is not cumulative unless the transactions occur in that period. Meaning all activity during the period is included but previous activity is not (unlike the balance sheet where those balances are a result of all previous transactions. A good way to think about it is the P&L is a snapshot whereas the balance sheet is the long story of your company since inception.

Revenue

The top lines of the report is revenue for the period of time covered. Revenue includes all sources of income, including sales from operations, interest and investment income, revenue from insurance claims, sales from assets or other parts of the business, and any other source of revenue. In most small businesses, sales will be the largest part of the revenue, if not all of it.

If a company sells more than one item or has more than one location, it might be a good idea to be able to view the sales detail from these categories. This may or may not be on the income statement depending on how formal it is, but business owners should be able to get a drill down report on their sales detail.

Revenue also includes any returns, refunds or chargebacks. If a retail center sells two shirts for $100 and one is returned, the Gross Revenue will be 100, less refunds of $50 giving a Net Revenue of $50.

Cost of Goods Sold

This section of the income statement includes costs incurred directly for the production of revenue. This includes materials, labor, or cost of finished inventory sold. If the business owner is a manufacturer, cost of goods sold (COGS), will include costs of raw materials and labor to produce the items.

Most companies have some form of COGS. Even firms that offer professional services can benefit from allocating the labor cost of a lawyer or accountant providing the services.

Gross Profit

Gross Profit is the difference between Revenue and COGS. It’s probably the most important metric on the P&L and if a business is not hitting it’s GP targets, it’s almost certainly not going to meet its Net Income targets.

Expenses

The expenses section of the income statement is the typically the longest. It includes all of the overhead expenses incurred by the business, including advertising and marketing, rent, telephone and utilities, office supplies and meeting expenses, travel, meals, entertainment, payroll and payroll taxes, and several more. Remember, if it’s associated with producing revenue, it probably should be in COGS.

Net Profit or Loss

The final number on an income statement is the one that most business owners know already. The formula is simple: revenue less COGS less expenses equals net profit or loss.

Net profit/loss can go by many names, depending on the size of the business and its accountant’s or management’s vernacular. These include EBITDA (earnings before interest, taxes, depreciation, and amortization), as well as earnings.

Analysis

Now that we have an understanding of the Income Statement, let’s discuss the information it can provide. Gross Profit Margin and Net Profit Margin are extremely telling and allow business owners to quickly measure the efficiency of their operations. Accurate and detailed budgeting allows business owners to measure their spending levels to maintain accountability and avoid wasting resources. Finally, taking historical numbers and combining them with forecasted data based on updated assumptions allows management to predict year-end results and predict the impact of decisions made today.

Perspective

It’s a good idea to compare income statement numbers to other periods in the business. Common comparisons include last period, last several periods and same period last year.

If the business falls into a standard type of business, entrepreneurs may also be able to see how the company is doing compared to others in the industry. This is called benchmarking, and the income statement is a very common format that’s used in benchmarking.

Lucrum Consulting encourages all business owners to spend some time each period reviewing their company’s income statement. This will help the business make a faster course corrections so it can achieve even greater success in the marketplace. Need assistance decoding your business’s income statement? Call Lucrum Consulting at 704.927.0462 for assistance.