The Bottom Line: How to Use Income Statements
An income statement is a way to measure your business’ performance over a period of time. It records your sales, profit/loss and cost of sales. It is also called the profit and loss statement. This is because your revenue minus your expenses equals the overall profit/loss.
Eq. 2: Revenue – Expenses = Overall Profit/Loss
An income statement has a detailed format. The heading should state the month or year which the income statement is covering.
The first thing we place in an income statement is revenue, followed by cost of sales, the gross margin (also called operating profit), expenses, and finally profit/loss.
Here are the simple definitions of each of those terms.
Profit or Loss. This is the bottom-line takeaway. This determines if you made any money after costs and expenses are subtracted from your revenue.
Cost of Sales. This lists the costs of making or selling the product or service (cost of labor directly related to the sale, cost of materials/components that go into the products, etc).
Revenue. Also called sales. You can list your revenue as one category or you can split it up into multiple categories separated by specific products. For reasons that we’ll get into later, it is preferrable to have a separate revenue account for each product.
Gross Margin. Also known as operating profit. This is the amount remaining after deducting the cost of goods from your income. Gross margin gives you the amount of profit made before covering other administrative costs of the business (e.g., rent, advertising, wages).
Expenses. Also known as operating costs. Whether or not you sell anything, your business still has to pay for things like rent, repairs, utilities, subscription fees and maintenance costs.
Here is an example of an Income Statement:
The Bottom Line
The Income Statement is a useful tool for measuring the sales of each category or product over a certain period. You can know which products are the best sellers and which are not selling so well. By keeping an eye on these figures over several months or years you can understand which of your products/services need to be boosted with more advertising.
Through the income statement you can also record the direct costs of running your business. You can understand the components that make up the direct costs, e.g., labor and materials. As the saying goes: knowledge is power, and knowing which parts of your business are bringing in more profit or expenses is vital to being a successful business manager. For more information on this topic, we strongly recommend that you pick up the book that inspired this article, which is entitled: “Accounting for Small Business Owners” by Tycho Press.
Of course, the best way to keep everything systematized is to digitize your financial records. That’s where free accounting applications like Lista can come in handy. With Lista acting as your pocket accountant, you can easily convert your transactions into an organized profit and loss statement.