How to read a financial statement
The income statement is one of the most important financial information in your business and its unfortunate that most small businesses do not realize this. Many small businesses don’t have a solid foundation when it comes down to reading and analyzing financial statements. They are only interested in the number that appears at the bottom of the page (the net income or loss) and base the business’ success on that amount or worse, the bank balance. Though that amount does provide you with the profitability of your business, there are more factors to consider.
An income statement can tell you a lot about the issues going on in a business, even if your net income is positive. Your low amount or negative amount may indicate to you that your business is not generating enough sales when in fact, it’s your business expenses and production costs that are the problem: they are unreasonably high.
Knowing how to analyze an income statement will provide you with a better understanding of the finances in your business. It is also an asset to your business planning.
Simple Breakdown of an Income Statement:
What an income statement tells you:
- The company’s performance over a specific amount of time
- The profitability of the company i.e. your profit margin
- Revenue (sales): this indicates the total amount of money coming in to your business i.e. sales
- Cost of Goods Sold (cost of revenue): this represents the cost in creating the physical product, such as labour (hourly wages) and material cost.
- Gross Profit: Revenue – COGS = Gross Profit The gross profit is the amount that will be covering your expenses. It’s a good sign if your gross profit is greater than your expenses, as all the expenses needed to run your business will be covered
- Expenses (operating expenses): these are the expenses needed to run your business. This includes administration, salaries and benefits, rent, advertising, insurance, utilities, office supplies, depreciation, etc. It includes anything and everything that you spend to support your business.
- EBIT (earnings before interest and tax): Gross profit –Total Expenses = EBIT This represents the total amount of money left over after covering the expenses. This amount will then pay for the interests and taxes.
- Interest and Taxes: when you borrow money and take on debt, there is a percentage amount that you must pay periodically to the lender. In addition, the government requires you to pay an established percentage, also known as the tax rate, of your sales to them.
- Net income (loss): EBIT – Interest + Taxes = Net Income or loss This is the final amount after all expenses have been taken away. This signifies whether your business is generating profit or not.
The income statement is an important tool in helping you review and study how you’re generating income and also spending to generate that income. To be clear, this article is only a surface level discussion about income statements. Income statements will differ from one company to the next. Discuss with your accountant how to get a more detailed discussion about how it relates to your business.
With our monthly bookkeeping service, you get an income statement each month so that you can evaluate how your business is doing.