The Income Statement, also called Profit and Loss Statement, is another report included within the Financial Statement. Last month we discussed the Balance Sheet, which reports a running net worth of your business by breaking out assets, liabilities and owner’s equity or net worth. The Income Statement is different, in that it reports within specific time periods, such as monthly, quarterly or annually. This document is necessary to determine tax liability, or more importantly to reflect whether the owner’s equity is changing for better or worse. It also lets a business owner know how their financial decisions are impacting their overall success.
This financial statement has areas that appear to be quite straightforward but others are a little more daunting at first glance. Having everything accounted for accurately is one thing but what does it all mean? This post breaks it down for the small business owner so that you can easily read a small business income statement.
Revenue contains all the income earned from sales of goods and services. This line item is listed as the top item on the Income Statement from which all charges, costs, and expenses are deducted to determine a net ordinary income. Other income items, such as gain on sale of fixed assets or transactions not involved in daily operations will be discussed later in this section.
Cost of Goods Sold
COGS are expenses that are required and used to generate income. Cost of Goods Sold (COGS) is determined by taking the beginning inventory + purchases + ending inventory, the difference is inventory used to produce goods sold. A good example is, if you were to sell a pair of jeans for $80, you would indicate that amount in revenue. Then you would list what the jeans cost you to purchase or manufacture in the COGS column. Let’s say that the jeans cost your company $20 in materials and time; $20 would be placed in this column for each pair of jeans sold to reflect their cost. If your company provides a service and not a product, this figure would reflect the total number of man-hours used to perform the service
Gross Profit, also called gross margin is the amount and percentage from revenue minus cost of goods sold. Gross Profit is important because it indicates how efficiently the business owner and management uses labor and supplies in the production process. It’s a very good indication of how profitable a company is at its most basic level. Companies with higher gross profit will have more money left over to spend on overhead expenses, operations and other business matters such as research and development.
Operating Expenses also referred to as Overhead Expenses incur during the routine carrying out of day-to-day business. These expenses, to mention just a few include business insurance, rent, office supplies, office payroll, workers compensation, annual licenses and permits, travel and other general expenses.
Net Ordinary Profit
EBIT (Earnings before Interest and Taxes) is the sum or Gross Profit less Operating Expenses. Net Ordinary Profit is the results of a company’s primary business operations. Not to get too deep into tax matters, but ordinary profit is taxed differently than other types of income.
Other Income/Expenses is the last section of an income statement and reflects extraordinary income and expenses. For example, Gain or Loss on Sale of Fixed Asset, interest or dividends earned. Rental income is another example, if you have a spare office you decide to lease and it’s not your primary source of income. In summary, any activity that is not part of your primary business and is taxed differently than ordinary income, such as capital gains taxes.
Net Profit (Loss) is your bottom line! Since our focus is small business owners, the subject of income taxes is not included in an income statement. If you are a sole-proprietor, LLC, Partnership or S-Corporation, your business will not pay taxes. Rather, the taxable income will flow over to your personal tax return. For this reason, tax refunds and estimated tax payments have not been discussed.
Read Your Small Business Income Statement
Income statements are the key to understanding the health of your company. If you’re looking for someone to help you get your financial systems and processes in order to further improve the health of your business, give me a call today.