Making sense of income statements

Knowing what an income statement is, what it contains, and how it is used is going to go along way towards helping you to understand and make sense of your income statements. And making sense of your income statement is key to successful business.

What is it?
An income statement, is also known as a profit and loss statement. This is a summary of a company's profit or loss during a given period of time. The income statement records all revenues, as well as the operating expenses for the business.

So, now that you know what it is, what is it used for?
An income statement is used to track revenues and expenses so that you can determine the operating performance of your business over a specific period of time, whether that is a month, or a year.
Some use income statements to find out what areas of their business are over budget or under budget. This is generally only something small businesses can do. However, income statements show specific items that are causing unexpected expenditures, you can use them to pinpoint these expenses, and thus address them. For example, you may not realize just how much you spend on long distance phone, and fax, expenses. But when you look at an income statement, you can look at how much you spend there in comparison to other areas. For example, if you spend $100 a month on phone, and only $50 for advertising, then your phone is obviously over budget.
Many use income statements to track products in general. You can use these income statements to see dramatic increases in product returns or cost of goods sold as a percentage of sales.
Income statements are commonly used to determine income tax liability.

To make sense of income statements, let's now take a look at what is generally included on them:

1. Sales: each income statement will show a sales figure. This represents the amount of revenue generated by the business. So, this number is key. However, you have to understand that it needs to be total sales, minus any product returns or sales discounts.


2. Cost of goods sold: This number will show you how much each of those sales cost you, it is the costs directly associated with making or acquiring your products. So this is cost of materials, as well as any cost of manufacturing, shipping, etc. Thus, this helps you determine your gross profit. If you own a business you should already know this, but gross profit are found by subtracting the cost of goods sold from net sales. It does not include any operating expenses or income taxes. (hence the next thing in your income statement).


3. Operating expenses: Obviously your income statement will want to show the daily expenses incurred in the operation of your business. So, this part of your income statement includes salaries, collateral, promotions, advertising, and other sales costs, and the costs associated with running an office, like rent, utilities, etc. Any depreciation, overhead, etc. is placed in this category. So, when trying to make sense of your income statement, know that this includes everything from paying the cleaning lady to paying the boss, or sending out mailers


4. Total expenses: next you will see total expenses, which is simply a tabulation of all expenses incurred in running your business. There is exception of taxes or interest expense on interest income, if you happen to have any.


5. Net income before taxes: the next part of your income statement is a number that represents the amount of income earned by a business prior to paying income taxes. So, in other words, subtract the total operating expenses from gross profit.


6. Taxes: You just can't avoid them, so make sense of them. This part of your income statement is simply the amount of income taxes you owe to the federal government and, state and local government taxes.


7. Net income: Now that you have the number you should be most interested in-the amount of money the business has earned after paying income taxes.