Income Statements 101: What Business Owners Should Know
Business owners must have a good understanding of their financial performance. Even if the owner is not the company accountant, they should know how to read financial reports and use them in decision-making. A profit and loss statement is an example of a report that business owners can use to understand their financial standing. Here are things you should know about this document.
What Are Income Statements?
An Income Statement or a Profit and Loss Statement is a quick overview of the revenues and expenses of a business over a specific period. The profit and loss statement can compile data in monthly, quarterly, or annual terms, though it is also possible to use shorter periods like days or weeks.
Accountants sometimes refer to P&L statements as financial performance statements, operations statements, earnings statements, or expense statements. P&L management involves evaluating how a company handles cost and revenue matters.
What Do Profit and Loss Statements Contain?
Generally, P&L statements contain the company's revenue or sales figures over the specified period. It includes information like the cost of goods sold, cost of sales, and marketing or advertising costs. It also contains general and administrative costs, interest expenses, tax liabilities, and interest expenses. The net income of the business is also part of the P&L statement. A highly simplified formula that all income statements follow is:
Revenue - Expenses = Profits
Ideally, the business has a positive number at the end of all the computations—this indicates profit instead of loss. That said, loss is common, especially among businesses in their first months or years of operation. To be sustainable, though, a business needs to show a positive upward trend. When it does, it means the company is profiting more and more every time you generate a new income statement.
What Else Do Income Statements Tell You?
Besides showing your business's profitability, total revenue, and total expenses, a P&L statement can help your company accountant figure out more than your tax liabilities. An income statement lets you find your break-even point or the number of sales you need to cover operating costs.
It can also help accountants in scenario planning or determining the most likely outcome of increasing prices, launching a promo, or developing a new line or product. Income statements are an excellent tool for determining your business model's viability. It also provides you with the data you need to cut costs and generate more revenue.
How Do You Read an Income Statement?
An income statement has plenty of valuable information, but it can be overwhelming for someone with no experience in reading one. Here are the things you should see in an income statement and what each portion describes.
The revenue is the company's net sales or total turnover for the given timeframe. It includes income from your primary business activity and non-operating revenue like the sale of business assets.
Cost of Goods Sold
This figure shows the total cost you spend on delivering products and services. The cost of acquiring inventory, cost of raw materials, and labour cost are all items you can put under this category.
The gross profit, also known as the gross income or gross margin, is the net revenue in a given period. It is the profit you gain minus the cost of sales.
This figure is the total amount you earn when you deduct all of the expenses for the specified period. You get the net profit by subtracting total expenses from gross profit.
The operating expenses are the administrative costs of running your business. Rent, utilities, payroll, and other things you must pay to operate are part of this column. Non-cash expenses like equipment depreciation are part of operating expenses as well.
Your operating income consists of your earnings before taxes, depreciation, and interest. Deducting operating expenses from gross profit will give you the operating income.
An income statement is a valuable tool for gauging where your business is and where it is going. If you learn to read your income statement, it will help you make high-level decisions that would benefit your company in the medium and long term.
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