Make Better Financial Decisions By Better Understanding Your Income Statement

Make Better Financial Decisions By Better Understanding Your Income Statement

How often do you check your business’ income statement?

When you run a small business, information is your best friend. The more information that you have at your fingertips, the better the decisions you can make for your future. Being able to review your numbers and pull out key data at a moment’s notice is essential when you’re a small business owner.

One of the best ways to measure the health of your company is to check your income statements periodically. This is one of your company’s primary financial reports, sometimes referred to as the Profit & Loss Statement. This document is generated monthly, quarterly, or annually to provide an “in progress” snapshot of the current performance of your business.

What Is Its Main Use?

The primary use of the income statement is right there in the name. It’s a document that you can use to measure whether or not you’re bringing in money. “Bringing in money” doesn’t necessarily mean that you are saving money in the bank, however; to do that, you need to check your Cash Flow Statement.

The information contained in your income statement describes your net profit. In other words, your revenue minus your expenses will equal your net income.

Let’s Look at Revenue

When you generate income through your business operations, that’s your revenue. You might have a number of different revenue sources, depending on your business, which should appear at the end of each section of your income statement. This division can help you analyze which of your departments is performing best and where you might want to put your resources in the future.

This kind of information can be very useful for streamlining operations as it can help you focus in on the most profitable aspects of your business.

Let’s Look at the Cost of Sold Goods

If you’re an inventory-based business (as opposed to service-oriented), then the Cost of Goods Sold (COGS) is the key to understanding your income statement. Your COGS is the cost of your inventory sold within a given time frame. For example, if you buy approximately $10,000 worth of inventory and only sell 20% of it, then your COGS will be equal to $2,000. The rest ($8,000) can only be expensed once sold. Otherwise, it will be considered an inventory asset of your business.

Before purchasing inventory, it’s important to know what you already have in stock. That’s where your balance sheet can come in handy.

Let’s Look at Gross Profit

Gross profit can be boiled down to a simple equation:

Revenue – COGS = Gross Profit

This is a subtotal within your income statement and represents the revenue that you can disperse on your other expenses after you purchase your inventory. When this is expressed as a percentage, it’s called a gross margin. It can come in handy when you want to make decisions regarding your business taking on more expenses. It’s expressed through this equation:

(Revenue – COGS) / Revenue = Gross Margin

The Gross Margin will, of course, be different for various industries. You should do some research (or ask an accountant) to determine if your Gross Margin is comparable to your competitors’ as a metric of the health of your business. If it’s too low, it means that you are spending too much on inventory, or your sales prices are too low. This could indicate that you should be looking for more competitive prices for inventory or that you should increase your sales price.

Let’s Look at Fixed Costs

Fixed costs are the expenses that are easy to predict. They occur monthly, regardless of your overall sales or other costs. They can include your monthly rent, hydro, water, business and inventory insurance, marketing, and employee salaries.

This is another place where you might want to look at industry benchmarks to determine if you are overspending. For example, if your rent accounts for more than 50% of your fixed costs every month, you are likely paying too much. It could save you money in the long run to start looking for another location for your business and/or try to re-negotiate with your landlord. You could also consider cutting down on the space used for your business and sublease the rest. Always be sure to calculate the percentage of each fixed costs against your overall revenue.

Let’s Look at Variable Costs

These are the costs that vary month to month, depending on your sales and other occasional expenses. For example, if you start to sell more of your products, then the cost of packaging is likely to go up.

Your variable costs will likely fluctuate, depending on whether you are experiencing an increase or decrease in your sales numbers. If you are experiencing a temporary downturn of 20% in sales, but your variable costs remain constant, then you might need to explore some ways to cut down on that overspending.

Variable costs can vary wildly depending on if you are in a slow or rush season. You should constantly be tracking these costs through these seasons to make sure that you are slowing your spending during the slow season to save yourself money.

Basically, your income statement all comes down to this: to figure out your bottom line, you need to subtract your expenses from your gross profit. If you discover that you’re in the black, that’s great news—it means your revenue exceeds your expenses! Yay, profit! If you’re in the red, that unfortunately means you’re going to have to figure out how to shuffle things around financially to get yourself in the black. This can happen periodically, depending on variable costs during slow and rush seasons, so you always need to be on top of your income statement.

If you’re having trouble figuring out the areas where you are overspending and underperforming, we can help. At The Number Works, we can give you a more complete understanding of your income statements and show you places where you might be able to streamline your business. So, feel free to contact us today! We can’t wait to help you better understand all of your financial statements!

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