Income statements – commonly known as profit and loss statements in Australia – are similar to the scorecard in sports, or the nutritional panel on food packaging. They sum up the events and performance of your business finance over time in one easy-to-read guide, but how do you get the most out them to help boost your bottom line?
Breaking It Down
The first stage of increasing the effectiveness of your profit and loss statement is knowing the sum of its parts.
The most common features are:
- Heading: identifies the business, the financial statement type and the time period, for example, ‘For the period ending 31 March 2015’
- Body: profit and loss statements are designed to be read from top (revenue) to bottom (net income). Each rung down the ‘ladder’ will see your top line encounter another expense. A double underline represents the final number (or bottom line)
The body, from top to bottom, includes:
- Cost of goods sold expense
- Gross margin
- Operating expenses
- Operating income
- Earnings before taxes
- Net income
Things to Remember
- No minus signs; parentheses represent negative numbers. For example, Net Income … ($156,000) means a loss of $156k
- Profit isn’t always called ‘profit’. It can also be referred to as income, while a loss can also be called a burn
- There are no sales breakdowns on an income statement; the number of purchases won’t be found here
- Operating expenses (also known as selling, general and administration expenses) are usually just all lumped together and include costs, such as wages, insurance premiums, advertising, legal costs and others
Why Is It Important?
The profit and loss statement is vital to the business owner because it demonstrates profitability over a given period of time. Without it, investors, banks and business leaders would have no idea how the business is truly performing or where it can be improved. It’s evidence of good (or bad) business.
If a business operates profitably, for example, banks could be more inclined to extend credit to the business – even more so if the organisation had taken on debt previously and continued making money.
Getting the Most Out of Profit and Loss Statements
Once you’ve got together a few profit and loss statements, you can start analysing them to identify trends. Once you’ve identified some trends, you can start trying to reverse or capitalise on them.
A healthy trend, for example, might be revenue growth outpacing expense growth. If you find yourself in a situation where expenses are growing faster than revenue, trimming back costs should become a top priority for the next couple of quarters.
Another way they can help your business is using them as a benchmark against other small businesses. Obviously, your competitors aren’t going to hand over this information easily, but talk with your network and see if you can do a data swap that is mutually beneficial. Participants from the recruitment industry in Australia, for example, submit their income statements anonymously to a third party who analyses the data and distributes the findings to its members every month.
The Cash Flow/Profit and Loss Statement Combo
Profit and loss statements help you boil financial information down to a simple equation. Adding in a cash flow statement to this information will give you a much broader view financial health of your business.
Cash is king, and having full coffers means your business is ready to move on any opportunity. However, if your business has a healthy net income but a negative cash flow, it’s a pretty big red flag and can grind your business to a halt while you liquidate assets to pay bills. Cash flow forecasting is one way to keep this issue in line.
Crunching the numbers doesn’t have to be daunting. Some software platforms can help you automatically produce income statements, reducing the stress in your life.