Rarely does the jargon of accountants and business finances permeate popular culture. We have yet to hear a rapper drop a clever rhyme about accelerated depreciation (though hope springs eternal).
Still, there is one notable exception: “the bottom line”. There’s a good reason this financial term has become shorthand for the essence of an idea, or the crux of an issue… like the Hokey Pokey, the bottom line of your Income Statement is what it’s all about.
Also known as the Profit and Loss Statement (P&L), your Income Statement provides invaluable insight as to whether or not your business is performing well. And as a business owner, being able to read the Income Statement and understand not only the pure numbers, but what they indicate about your business, is absolutely vital.
Below you’ll find three ways your Income Statement can illuminate your company’s financial picture, and ways to course-correct if that picture is looking shaky.
It tells you whether or not your business is profitable.
Many financial documents fly across a business owner’s desk in a given month, but the one to consult when you’re wondering whether or not your business is making a profit is the Income Statement. Unlike the Balance Sheet (click here to see last week's blog), which is an overall picture of your company’s finances at a certain point in time, your Income Statement calculates business performance over a period of time. If you’re wondering exactly how much profit you made or lost last quarter, you’ll pull up your income statement for that time period.
The simplest way to think about an Income Statement is that it’s not that different from your own personal accounts. At the top is how much you earn in, say, a month (the company’s gross revenues and sales). Then on each descending line you subtract life expenses like rent/mortgage, insurance, gourmet dog food, your kids’ allowance… you name it. The company’s expenses are likely to be things like rent, insurance, cost of goods, and employee wages (though hopefully you’re paying your employees slightly more than your kids.)
You go down the line, subtracting those expenses one after the other. Keep in mind that this is a simplified explanation, and many other things like deprecation and taxes are taken into consideration by your meticulous accountant.
You finally arrive at the bottom line: the net earnings or losses from the period. As with your own bank account, you hope to end up with a positive amount at the end. But of course, with a business, this isn’t always the case. If you have a period of time when your spending is outpacing your revenues, it’s not always the end of the world. But it is something to keep a very close eye on, and work to fix quickly. And the income statement can help with that as well.
It provides a diagnostic of your company operations.
In good times and bad, the Income Statement is a useful tool for examining the spending habits and efficiency of your business venture. Just as you go get a yearly check-up at the doctor (or at least you’re supposed to) whether or not anything is urgently wrong, sitting down with your Income Statements can be a smart way to diagnose the overall performance of your company.
Every company and business owner understands the importance of a business’ primary revenue stream. After all, this was probably the core of your pitch when getting that initial capital. You wanted to sell t-shirts for hamsters, or run a chain of restaurants that only served gourmet macaroni and cheese on bamboo platters. And somebody thought it was a great idea! But even if your revenue is in the black, it’s always smart to keep an eye on the costs and expenses associated with earning that revenue.
If, for example, you find that you’re using a large chunk of cash to rent equipment, (perhaps for your artisanal cheese) it may be time to explore whether buying would be a better long-term option. And looking at any secondary or ad-hoc revenue and expenses can be a good place to start tweaking as well. For example, if you’re earning a lot of interest on money tucked away in the bank for a rainy day, it may be an indicator that some of this money could be freed up for expansion, or be reinvested in your own company.
It offers valuable feedback during hard times.
Of course, things don’t always go smoothly. Luckily, the Income Statement is there to warn you. If something’s eating into your margins, you want to know sooner rather than later.
Has there been a blight on the dairy industry, raising the price of your gourmet cheese production? You want to know now, so that you can understand why your profits are declining, whether or not this is a permanent or temporary state of affairs, and whether or not you need to go to a cheaper bamboo platter supplier or raise your prices slightly to make up the difference.
When something catastrophic and unexpected happens (remember 2020?) you may find yourself in a tough situation where net earnings have turned into net losses. Fortunately, your Income Statement provides not only a clear and immediate indicator of that fact, but has the potential to show you how to fix it.
The Income Statement will help you find those little leaks in efficiency and plug them right up. Maybe you need to source new suppliers to provide less expensive noodles. Maybe you don’t need to buy custom bamboo platters— your customers will still enjoy the macaroni and cheese from a normal ceramic dish. Or maybe you need to completely overhaul your business model to include a wider variety of food options.
The Bottom Line
Whether or not you have mac and cheese problems, your Income Statement is going to serve as an important financial tool in good times and bad. Beyond simply listing net profits, it’s vital for improving the margins of your business, and a lifeline in hard times to help you make the tough choices. And if you need another, more experienced eye on those finances, reach out to Know Your Numbers Accounting at any time.