Financial statements are some of the most critical aspects of running a successful business, yet they often leave business owners feeling confused and overwhelmed.
At our last ACTIVATE Women session, we kicked off our 3-part series on financial statements by hearing from Rhonda Elkin, Kait Nichols, and Chontay Clements with Schmitz-Holmstrom, CPA about the income statement.
Here’s a quick recap on what they covered.
What is an Income Statement?
The Income Statement, also known as a Profit and Loss Statement, is a document that shows the profitability of a company over a certain period of time. The data from this financial sheet can help a company evaluate past performance as well as help forecast future cash flows.
Basic Structure
Income statements often show company profitability over different periods of time, such as year by year in the example. Below is a very basic example.
The first half shows the Gross Profit of the company. This is found by taking the Revenue (or Sales) in that time period minus the costs directly related to making or selling the products and services, known as Cost of Goods Sold.
The second half of the income statement is where any other income or expenses are recorded, such as general or administrative expenses, operating expenses, interest expenses, etc.
At the very bottom is where the Net Income is calculated. This is the most important number on the Income Statement, as it shows how much a business is actually profiting from the sales of their goods and services. This number is found by taking the Gross Profit minus all other expenses.
Common Ratios
Not only does the Income Statement help show a business’ profit, but its components can be used to calculate other ratios that help indicate the health and success of a business.
Gross Profit Margin:
This number helps showcase the profit made from a sale before subtracting any other expenses, giving businesses a good idea as to how much profit they take in from their goods and services alone. The Gross Margin is shown as a percentage and is calculated using the formula below:
Gross Profit Margin = (Gross Profit / Sales) x 100
Using the numbers from the Income Statement example above, The College Shop’s Gross Profit Margin for 2017 was around 36%, meaning that for every $1 generated in sales, the company generated $0.36 in gross profit before all other business expenses were paid.
$213,000 / $600,000 = .355 x 100 = 35.5 or 36%
Net Profit Margin:
This number also helps indicate the profitability of a business by calculating how much revenue actually translates into profit for a business after all other expenses are deducted. Also expressed in a percentage, the Net Profit Margin is found by using the formula below:
Net Profit Margin = (Net Income / Sales) x 100
Using the numbers from the Income Statement example above, The College Shop’s Net Profit Margin for 2016 was 6%, meaning that for every $1 generated in sales, the company kept $0.06 as profit.
30,000 / 500,000 = .06 x 100 = 6%
Tips and Tricks
Here are a few tips to ensure the proper understanding and use of an income statement.
- Be Consistent – An income statement and the calculations that derive from it mean nothing if not everything is reported. Therefore, it is critical for a business to stay on top of tracking all revenues and expenses and be sure they are reflected in the income statement.
- Monitor on a Regular Basis – These numbers give great insight into how a company is going and if the revenues and expenses they incur make sense. Monitor these numbers and the ratios that they can calculate on a regular basis (monthly, quarterly, or yearly, etc.) to ensure the business is making money, spot any unusually high or low numbers, and even forecast seasonal trends.
- Analyze Financial Performance – a standalone income statement doesn’t really tell much of the story. For the full picture of how a business is performing, it is important to compare the current statement against prior years (for the same period) and against budget. This will allow the business owner to spot trends and make adjustments to ensure the business is being managed for profitability and overall success.
- Use Proper Judgement – Even if everything is reported, there may still be errors in the income statement. That’s why this document relies heavily on the judgment of the business owner using it. Look into things that might look off (too high, too low, etc.) and investigate – it may be a reporting error, or a good look into something the company may have to change. There are many, many mistakes commonly made by new business owners in financial reporting. Be sure to consult with an accountant to help guide and provide advice on current financial record keeping.
Other Resources
For questions, assistance, or more information on the Income Statement, check out the following resources:
- Profit Mastery – offers frequent webinars to help get a better look at financial statements
- SCORE – a mentorship program giving one-on-one assistance to business owners
- Local Accountant, Advisor, or Mentor – the best way a business owner can learn and understand their income statement is to utilize and ask the experts in their network
- Quickbooks – this program is a simple, all-encompassing software program that allows business owners to track and report all expenses, as well as generate financial statements automatically
Stay tuned as our presenters continue the conversation and do a deep dive into the Balance Statement later this fall!
For more information about Schmitz-Holmstrom, CPA, visit their website.