What does an Income Statement tell you?
Also known as a profit and loss statement, an income statement is a moving picture of your business identifying how much revenue your business earned minus costs and expenses over a specific period of time. An income statement works together with a balance sheet and cashflow statement to provide you with important information about the health of your business so you can make informed decisions.
The typical income statement formula is:
REVENUE - EXPENSES = PROFIT OR LOSS
Revenue
At the top of an income statement report, you’ll see gross revenue including the total sales of goods and services completed in a given period, usually displayed monthly over a 1 year period.
Keep in mind how the payment collection policies you have in place impact when you actually receive funds. For example, in service based companies, invoicing can be based on progress completed or have set payment dates based on a contract. In construction companies, milestone payments may not align perfectly with work completed. Most often, the revenue recorded on the income statement has been “earned” in the given period.
Cost of Sales + Labour
These are costs directly related to producing your product or delivering your service. They go up in direct relationship to your sales depending on the type of business you have and the industry you are operating in.
In construction or contracting, examples of costs would be labour, raw materials, and all direct expenses required to complete a job. Typically, you don’t have a lot of control over these expenses. To lower expenses, you may be able to negotiate pricing and payment terms with key vendors you build relationships with depending on your order volume, consistency, and reliability. You can also lower costs by finding ways to run your operations and jobs more efficiently with better systems and processes.
Gross Profit
Gross profit is calculated by subtracting the cost of sales earned (Including materials, labour, operating expenses) from your total revenue.
Operating Expenses
Operating expenses cover all the things you need to spend money on to run your business. Here are the main categories:
1. Labour - all the people needed to keep the business running (this may include employees, contractors and freelancers)
2. Materials - the cost of materials required to sell your products and/or services
3. Marketing - the money spent to keep the sales coming in
4. Equipment - the equipment and/or tools needed to do the work
5. Other operating expenses - this includes recurring and other expenses, which can vary depending on your business model. The goal is to keep this number as consistent as you can so you can plan ahead. It’s also important to dig into what’s included in this number to identify changes or improvements you want to make.
Net Profit (Loss)
Gross profit minus operating expenses equals your net profit. You pay tax on your net profit number.
Online accounting tools like QuickBooks Online or Sage Business Cloud make it easy to access your income statement and investigate any issues if something looks off.
It’s important to review your income statement monthly or quarterly at a minimum compared to previous periods to stay in control and troubleshoot potential cashflow problems before they happen. Complete an annual review to identify ways to improve your sales, income and profit and plan ahead so you can prioritize the projects that will have a positive impact on your bottom line.