How To Read Your Income Statement
Your income statement, otherwise known as your profit and loss statement (P&L), is the gatekeeper to business performance, offering a detailed look into revenues and expenses over time. Reported monthly, quarterly, or annually, your P&L will be a critical piece to building your future, allowing you to troubleshoot, fine tune, and plan for what’s to come.
In this article we’ll walk through the purpose of your income statement, how to read it, and how to apply insights to build a better business. If you haven’t been introduced to the Core Four Financial Statements, we recommend taking a look at our primer and coming back for a more detailed read.
With that said, let’s jump into it.
What is an Income Statement?
If your objective is to understand business profitability and dissect the line items increasing and decreasing your bottom line, the income statement is what you’re looking for. Incorporating revenues (and revenue sources), categorized expenses, and all other in-and-out-flows over a specified period of time, it offers a back-end look at the numbers supporting our business.
Think of your company financials as the floor of a ship at sea. Your balance sheet is the equivalent of a quarterly or yearly photo taken of the floor to show it’s condition. You’ll get a sense of how it looks, how it compares to years past, and if there are any issues needing your attention (i.e. lack of liquidity or… a hole). Your income statement can be comparable to an onboard camera filming events over the course of a month, quarter, or year. It will show you everything that goes on, both positive and negative, offering the ability to pinpoint specific trouble spots that the photo just wouldn’t allow for.
This is all to say your income statement should be used to flag issues and spot opportunities for change and growth. If particular business areas or expense categories are needing attention, this is where you’ll find out first.
Sounds great, right? But how do you actually read the thing?
Reading Your Income Statement
Your income statement will read very similar to your balance sheet, with a few minor differences. The first is that your income statement will go into greater detail for specific in-and-outflow figured over time.. This is great, as you’ll have a pile of information to assess business performance in very particular ways. You can see revenues, expenses, and profits down to the penny, with categories and descriptions explaining where the money came from and went. The second is that your income statement will tell a story from top to bottom, starting with your total revenues and working all the way down to the final net income figure. Here’s an example of what it’ll look like:
Your statement may have more (or less) detail than the one above (ideally, more), but it should give you an idea of what to look for. On your income statement, there are four key areas that you’ll want to look for:
- Gross profit is the amount of money your business made minus any costs associated with production, including raw goods, wages, and packaging.
- Operating income is the amount of money your company made once all expenses (aside from taxes, interest, and depreciation) have been subtracted. Operating profitability is a great number to look at when assessing long-term business sustainability.
- Earnings before taxes is your total income after everything has been subtracted (aside from government tax payments).
- Net income is the final figure you’re left with once taxes have been paid. This is money that can be reinvested into the business, paid to shareholders, or added to your cash float. This number is very important to pay attention to, especially for small-to-medium sized businesses. A positive number means you're operating profitably, and a negative means… well, you know.
Applying Income Statement Insights
As a solo statement, the best thing your P&L can do is open your eyes to areas needing improvement and focus your attention on areas where growth opportunities lie. If a new product category is growing far quicker than others available, maybe it warrants an increased investment. If an expense is bogging down your profitability and limiting your growth potential, maybe it’s time to sell the corporate jet. Good or bad, your income statement will provide the information necessary to guide the business.
There’s also an immense amount of value that comes with reviewing your income statement alongside your balance sheet and cash flow statement. The lesser of the two will allow you to see how weeks, months, or quarters played a part in the final figures logged. As the balance sheet is merely a snapshot in time, you’ll be able to take high-level concerns and drill into them with the help of your P&L. The latter will give you the chance to dive deep into the income statement lines. Your cash flow statement will detail the most granular in-and out-flows over time, and any trouble spots or growth opportunities pinpointed on the income statement can be further explored.
With that, you should now be ready to put your income statement to work for the better of your business. If your team has any questions, we’re always happy to chat.
Until next time!
