Whether you’re just starting out or you have been in business for years, understanding your financial statements can provide a great deal of clarity in regards to the health and vitality of your business. Over the course of many years, we have fielded numerous questions about what certain financial statements are meant to portray and how to interpret them. With that in mind we decided to answer some of the most common questions we received about the income statement.
Q. What’s an income statement?
A. An income statement is a summary of your income and expenses over a particular period of time. The income statement is viewed in a monthly, quarterly and yearly format. In the simplest terms, there are three major categories on your income statement: revenue, cost of goods sold (COGS), and expenses. Where most people get caught up is deciphering the difference between COGS and expenses. One easy way to look at it is that cost of good sold items are things that go directly into producing a good or service. This would be things such as the material needed to create a product or the amount of time it takes (labor) to assemble said product.
Q. What are the most important numbers on an income statement?
A. The easy answer to this question is Revenue, Gross Margin, and Net income. In understanding these numbers, you can get a solid idea of the growth, efficiency and overall health of your company. Your revenue number can indicate increased growth. Gross margin can provide a sense of how efficient your production effort are. Lastly your net income can provide a sense of how much money you are bringing in on a monthly basis.
When looking at an income statement it is important to understand what changed over the course of the period and why it changed. For example, if you have a significant increase in your marketing expense account and little to no change in your profits it may be a good idea to evaluate your marketing efforts. Therefore, looking at your income statement on a regular basis and understanding your numbers can weed out unnecessary expenses and inefficiencies.
Q. Can my income statement tell me if my business is doing well?
A. “Doing well” is a relative statement and is dependent on the various factors that affect your business—both internal and external. To elaborate, if you’re a new company with little to no revenue who is heavily investing in developing your new product or service, it is almost a given that you would have a very low or negative net income. Determining if your company is “doing well”, would be subject to whether or not these investments are eventually realizing into revenue streams.
Moreover, that is why it is important to review your income statement on a regular basis (typically monthly or quarterly). That way you’re able to see the progression of you business and understand whether your investments are truly paying off.
I hope this short Q&A provided some insight into how you should be looking at your income statement. If you have more questions about your income statement or your financial statements in general please feel free to reach out to us or check out our website at www.gaddbiz.com for more helpful videos and articles.