3 Tips on How To Read an Income Statement
Last week I was talking to an owner of a 100 million dollar company who was telling me that he wasn’t sure that he understood his financial statements. I was a little confused, how could someone build a successful business as he had in less than 5 years, not understanding how to read a financial statement? The truth was that because he was good at hiring great people, including a CFO (Chief Financial Officer) and had other skills, he hadn’t spent the time or been taught how to read his statements.
Many business leaders feel overwhelmed when reading financial statements yet they shouldn't be. Here are some tips on what you can look for on your income statement that will help you feel more confident.
Understanding what an Income Statement is. Income statements are sometimes called Profit and Loss statements for a good reason. They tell you how your business is doing over a period of time.
Tip 1: Ask for Comparative Statements.
Always ask your bookkeeper to provide you comparative statements. Looking at one income statement by itself can be misleading. Having a comparative statement means that you will have two income statements on one page. This year's period and last years. The periods should be the same so that you can compare apples to apples. Additionally you will also want to look at your year to date(YTD) income statement which will help you understand how you are doing over a longer period of time. Again ask for a comparative statement so you can see how you are doing compared to last year.
Tip 2: Income Statements are broken up into 3 sections.
The first section is the revenue statement and it shows where your income is coming from. It might be broken down into departments or divisions to enable you to see where the money is coming from. It also shows you what your cost of goods is and how much gross profit you have made. Gross profit is the money you have before your expenses.
A. Revenue: You want to be looking at these and asking: Are sales increasing or decreasing? By what percentage? Do you have certain departments that are growing or declining compared to the previous period? Why is that happening? What are the trends in the business? Are you doing anything differently that is helping or hurting sales? Why are certain areas outperforming others? The more you can figure this out, the better chance you have of being successful.
B. Cost of Goods Sold: Look at each line on your income statement. What has changed from the previous period? Can you explain the changes? Is there any input cost that you can reduce? Have your costs of goods increased or decreased?
C. Gross Profit: Look at the gross profit percentage compared to the previous period. Has it gone up or down? If the gross profit has gone down, you may need to make changes to ensure this does not continue. What needs to be done? If it is going up, good for you. Consider what you have done to make this happen. Can you continue to do this?
The second section is the expenses: This will typically be a list of different types of expenses and might have rent, labor, administration, insurance, utilities etc.
General and Administrative Expenses: Carefully compare this area line by line to the previous period. Are there expenses that have gone up? Why have they gone up? What needs to be changed? Are there areas where you can eliminate more costs? Remember that every unnecessary cost that you can reduce goes directly into your pocket as an owner! The last part of the income statement is your profit or loss it.
Third Section tells you if you made or lost money!
Profit or Loss: Compare your profit in this period to the previous period. Are you going in the right direction? Have you hit your goal for your profit? Are you happy with this number or discouraged? What needs to happen for you to reach your goals. Remember, you own the business to make a profit. This area is especially important! As they just check their bank balance when they are doing a deposit.
Tip 3 - Don’t Rely on the Bank Balance.
Many small business owners base their important decisions on what is in the bank on any given day. This is problematic. You are asking for trouble if you do not know where you are coming from, where you are going, or how well your business is doing. This is like driving a car without a gas gauge or a sports team not finding out until the end of the season if they have won or lost games during the season. You wouldn’t play sports or games without keeping score. Why play roulette with your business by not keeping score?
We need to get beyond the fear of looking at our financial statements. Once we know what we are looking for and understand how we can make the changes we need, our monthly comparative financial statements should be something we start looking forward to reading!
Dave Fuller is an award winning business coach and the author of the book Profit Yourself Healthy. If you need help getting your business report cards in order, he can be contacted at 250-617-7467 email email@example.com