First, let’s get the terms out of the way so we are all on the same page.
Income Statement = P&L statement = Profit and Loss Statement
These are all different names for the same thing. From here on out, I will use the term P&L to keep things simple and brief.
Many small business owners don’t know how to read their P&L statements. If you fall into this category, you are not alone, so keep reading as I break it down. Reading a P&L statement is an important aspect of any business. If you want to stay in control of your business’s finances, be sure to not only read, but also understand your P&L statement.
What is a P&L statement?
More formally known as a profit and loss statement or income statement, this report explains the profitability of your business over a specific period of time.
Many small business owners look at their income statements annually, at tax time (if at all). However, I recommend more often if:
You want to be in control of your business’s finances
You want to know whether you are profitable while you can still make decisions to improve or increase profitability (versus after the fact when it’s too late)
Breakdown of an income statement
You’ll notice when you look at your income statement, it’s broken down by line. Sometimes there can be many lines and this is where most people’s eyes glaze over when they begin staring at all the numbers. Here is one simplification strategy I share when I teach about income statements. An income statement is a simple equation:
Revenues – expenses = Net Income
If you remember nothing else, remember all the lines of an income statement fall into one of these 3 categories.
Your income statement, depending on the industry, will be broken down into more categories (which all fit into one of the 3 categories I mentioned above). These include; Total Revenue, Cost of Goods Sold (COGS), Gross Profit, General Expenses, Operating Income, Interest Expense, Income Tax, and Net Income.
Margin
One of the most important numbers on an income statement is the margin. The margin describes how much you get to keep of the money made when you sell your products and services. There are two types of margins.
Gross profit – Describes how much your business gets to keep after the costs to produce or provide the good or service (ingredients, materials, payment processing costs, etc.) are subtracted from the sales.
Net profit – How much money is left over after expenses to run the business (insurance, rent, office supplies etc.) have been subtracted.
The above numbers may be divided by total sales to create margin as a percentage of sales. So, for example, some businesses with higher margins get to keep 70% of the sales generated while others with lower margins may only get to keep 20%.
Some business owners are quick to share sales numbers. But these numbers don’t mean much unless they are put in thecontext of and shared with expenses and costs. How much was the business able to keep after expenses and costs were subtracted?
Reading an income statement takes a lot of patience. Without understanding it, you can’t ensure the maximum profitability in your business.
What other documents go with an income statement?
To make the most of your income statement and best track your finances, you will want to pair this with a balance sheet as well as a cash flow statement. For more information on cash flow statements, check out our prior blog post about them!
These three documents together give you a complete picture of the health and profitability of your business.
A balance sheet can tell you what you own, what you owe, and what is left over (called equity). A cash flow statement tells you where you cash came from and ultimately where it went.
Need guidance? I’m here to help. As a business solutions expert, I have helped dozens of businesses untangle complex issues and clarify a path to greater profitability.
Email info@ltaylorassociates.com so we can discuss how I can help.
If you enjoyed this content and want more of the same check out my free guide Do This, Not That: 5 Things Keeping Your Business From Reaching Its Fullest Potential where I discuss common barriers to profitability that I observe among most small businesses.