Small business owners must take on different roles to keep costs down – whether as a designer, copywriter, marketer, or accountant and being able to interpret income statements is included in the must-knows. You have to apply all the skills you have, or get the training to fill in the gaps.
One expertise that tends to be particularly difficult for small business owners is creating and managing income statements. Two primary financial documents that a business owner must have are a balance sheet and an income statement. On the balance sheet, you can see what you own (assets), and what you owe (liabilities) at a specific moment in time. Income statements show – by month, quarter, or year – what money is coming in and going out, and whether you made a profit or had a loss.
Owners use this critical document to analyze profit and loss, and to then make strategic decisions on increasing sales or reducing expenses. It’s also a required document to show to inventors and lenders.
What is the Story That Your Income Statements Tell?
Your income statements tell a story. They tell a story of how you grew or didn’t grow your sales. How much you spent to get sales. How much you spent to pay yourself and your employees. How much you spent on rent, phones, insurance and other expenses. And then finally the story of how much was left in profits or losses after sales minus expenses. Whether the story has a happy ending is up to you!
To help you, we’re giving you some tips on how to interpret your income statements:
A Reality Check For Your Financial Reports
Even though your income statements may be done on the computer, it’s a prudent idea to verify the data. One wrong number or an error in a calculation could make the statement virtually useless.
- Do you have all the needed categories for your industry (retail, manufacturing, personal services, etc.)?
- Are any figures missing (costs like association fees, licenses, or legal bills or income like earned interest, rebates, or sold equipment)?
- Are all the Excel formulas (like Sum) correct?
- Do the actual numbers make sense for each category?
Ensure you’re tracking all the right categories, and that the data makes sense.
The Income Statements Sources
It’s imperative to closely look at each one of your income sources. Ask yourself if this revenue is sustainable or not.
Analysis will show whether your current business model is working. If not, determine what can you can do to improve it, such as:
- Develop procedures or process flows to help your team become more efficient and, thus, faster
- Join a trade group like an industry association or community club like a local Chamber of Commerce to meet peers and potential clients
- Increase your online advertising to drive traffic to your website
- Hire a professional to help with weak areas like social media, copywriting, or sales
The Expense Categories on Your Income Statements
Most businesses share common expenses like rent, insurance, staff salaries and benefits, interest, taxes, and supplies. Keep an eye on these expenses to determine if all expenditures are shown, and if reductions can be made in areas like insurance premiums, inventory, or loan rates.
Consider whether expenses are appropriate for your industry; for instance, in a manufacturing business, supplies and materials should be your two largest costs. If you have a service business, you should see a bigger expense in salaries.
It’s also a good time to think ahead to planned future expenses like training or advertising, and to make adjustments as possible in other categories.
The Bottom Line: Your Profits
Particular focus will be on the number at the bottom of your income statement: Net Income value. When it’s a positive number, you have surplus income; when it’s a negative number, you have a loss for that period.
A positive number here indicates your business is making more money than what it’s spending for that period. It shows you’re doing a great job in managing business costs and generating sufficient income to be profitable. Congrats!
Positive income gives you the option to spend money on new equipment or software, advertising, or bonuses, or even pay yourself!
If the Net Income value is a negative value, it means that your expenses are higher than your revenues. The negative number can show enclosed by parenthesis, in red, or simply have a minus before the value.
When you see a negative value here, it doesn’t imply that your business is failing. Many businesses operate in the red for up to 3 years due to the numerous start-up expenditures like facilities, hardware, software, training, websites, and licenses.
A negative number can also be due to lower revenues or higher costs due to:
- ramping up your customer base through networking and word-of-mouth
- development of advertising, social media, and online content
- seasonal work such as farming, snow removal, roofing, or landscaping
- time for training and certification of staff
Assess the root causes for negative Net Income and make the moves toward improvements in the period that follows.
If you continue to have a negative Net Income, you need a deeper analysis to know where efficiencies and changes can be made.
Comparing Income Statements Side-by-Side
While looking at an income statement from a single period is important, it’s even more important to compare it to the previous ones. This is the only way that you have to see major trends in costs and sales.
Ideally, use an income statements template that will show a column with your last numbers. Use the comparison to become aware of any trends, seasonal affects, unnecessary costs, or other key information.
Once you can see the ups and downs in your numbers, you can address how to maintain the ups and to avoid the downs. If sales have declined, you can hire more staff. If insurance rates have increased, you can shop a better rate. If inventory is top-heavy, you can sell off the excess.
Reviewing the numbers in an income statement may not be the most exciting task of your day, but you should now recognize its importance in growing a successful business. You’ll know what is earning money, where your losses are happening, and how to get to the fun part – making more profit so you can expand your small business and fulfill your dreams.
For more information, here’s another article entitled “Why Measuring Results in Small Business is Crucial.” What are your thoughts about this topic? Is this helpful information? Reply in the comments below.