As an entrepreneur or business owner, you need to get to know your income statement. This critical document not only helps you understand the health of your business but where there may be potential risks, opportunities, and issues that need to be addressed. It’s a document that when read and analyzed can help inform your business strategy, set more accurate milestones, and better inform the goals you set for you and your team.
Like any financial statement, it can be a daunting task to try and understand how to read and analyze your income statement. But by taking the time to learn how, setting up a consistent review process, and equipping yourself with the right tools — it can become a fruitful and simple exercise. Let’s dive into how you can use your income statement to build a stronger and healthier business.
What is a monthly income statement?
Your income statement, also known as the profit and loss statement (P&L), summarizes your business revenue and operating expenses over a period of time. This is the most popular and most common financial statement in any business plan and helps you calculate your net income for that same period. The most basic use of your income statement is to tell you if your business is profitable or not.
Depending on the complexity and size of your business, you may find that your statement is fairly simple. But as your business grows, and you add more expenses, revenue streams, and other line items, it can become more complex. Generally, this is what you can expect to find on your income statement.
- Revenue or sales — The amount of money a business takes in
- Cost of goods sold (COGS) — The cost of what it takes to produce whatever a business sells
- Gross profit — Total revenue minus COGS
- Expenses — The amount of money a business spends
- Earnings before tax — Operating income minus non-operating expenses
- Taxes — Total tax expense
- Net earnings — Income before taxes minus taxes
What is the purpose of an income statement?
The purpose of an income statement is to display your financial performance over a given period. It’s the current snapshot of your actual business performance and it helps you define what occurred in a given day, week, month, and year.
Now, the true benefit of reviewing your income statement comes with comparing it to other financial documents. Looking between your cash flow statement and balance sheet, for example, can help you determine if your business is truly profitable, if you’re overspending and if you have a healthy level of cash to invest in your business.
Additionally, you want to leverage your income statement to understand if you’re performing better, worse or as expected. This is done by comparing it to your sales and expense forecasts through a review process known as plan vs actuals comparison. You then update projections to match actual performance to better showcase how your business will net out moving forward.
In short, you use your income statement to fuel a greater analysis of the financial standing of your business. It helps you identify any top-level issues or opportunities that you can then dive into with forecast scenarios and by looking at elements of your other financial documentation.
How do you analyze an income statement?
Your income statement is a great place to start your financial review meeting. Conducting an income statement analysis will help you answer key questions about your business, find opportunities for growth, and uncover potential problems before they have a significant impact on your business.
Here are 4-steps you can take to ensure each review is successful.
1. Check your bottom line
To kick off your review, look to the bottom of your statement. The number there gives you an idea of how your business performed during a specific period.
Typically, you want to see a positive number, meaning that you earned more than you spent. But if that bottom line is negative, that tells you what the focus of your review should be. You need to find out why you’re in the red and develop a plan for turning it around.
Keep in mind that a net loss once in a while does not necessarily imply disaster. Typically if you’re a new company or experiencing rapid periods of growth, you can expect a lot of upfront costs. Making it unlikely that you’ll turn a profit for a few quarters to a few years. This can also occur if your business is seasonal or cyclical.
2. Check your sources of income and expense categories
With your current bottom line in mind, it’s time to dive into the categories within your income statement. Specifically, your income streams and expenses. Starting with income, ask yourself the following questions.
- Do they make sense for the business?
- Are they sustainable?
- Has it grown gradually over each period? Or is revenue this period higher than usual?
- Is every revenue stream sustainable? Or are there unique line items this period?
Make sure you understand why your business performed the way it did. What events may have increased or decreased revenue and if that will continue over time. Now dive into the associated expenses.
Are they logical? For most businesses, you will see salaries and wages, insurance, rent, supplies, interest, and at least a few other things. Is anything missing that you would expect to see? Are there any specific costs associated with individual lines of revenue?
Like your revenue, try to uncover what leads to specific expenses and where you can work on reducing them. Again, you will likely have times where your expenses are higher than normal. But if they’re consistently rising while your revenue is stagnant or falling, you need to take a closer look at what and why your spending over the next period.
3. Compare your numbers
It was mentioned before, but part of your analysis is comparing results to the last month, quarter, and/or year. Usually, your income statement will have separate columns showing figures for these prior periods. If the document doesn’t already show the percentage change in every category, you’ll need to calculate those numbers yourself.
Connect results to projects, teams, or events that drove up revenue or reduced expenses. Question any significant changes. And then look ahead to what the next steps are based on those results and if any adjustments should be made.
Also, be sure to keep in mind why your business was performing the way it was during those previous periods. A dramatic uptick now may be due to poor performance at the same time last year. Not bringing that up can inflate your current results to appear incredibly positive. Meaning you’re still sustainable, but not improving like you could or should be.
4. Review your math
If you’re working off of a manual Excel sheet to build and review your income statement, you’ll want to double-check your math. Adding in numbers, changing algorithms, deleting cells can all lead to mistakes that affect your bottom line. If you can, review your previous period first to refamiliarize yourself with the statement and confirm it’s accurate.
Then move onto creating or updating your current period.If maintaining accuracy on your current statement takes up too much time, you may want to consider using a planning tool like LivePlan. LivePlan makes it easy to review your financials because it pulls in real-time data from your cloud accounting tool like QuickBooks or Xero. It’s seamless to compare actuals against your forecast.
Questions to answer during your income statement analysis
Here are a few of the key questions that you’ll answer when you review your profit and loss statement.
Did we have good sales last month?
It’s easiest to start your review at the top of the profit and loss and work your way down. At the top, you’ll find revenue, and that’s a great place to start.
When you look at your revenue from last month, you should compare it to three other numbers:
- Planned goal for revenue
- Revenue from last month
- Revenue from the same month last year
You’ll want to see if you met your goal for revenue and then answer the question, “why or why not?” If you beat your sales goal, you should discuss what worked better than expected. Are there successes that can be repeated? If you didn’t meet your goal, what prevented you from meeting your goal?
How did our sales compare to the previous month and year?
Ask the same questions about your sales compared to the previous month and the same month last year. A decline from the previous month might be fine if your business has normal seasonality. Most businesses will be looking to grow year-over-year, so comparing your sales to how you did in the same month last year is usually a good measure of your long-term success.
Now, look ahead at your plan for the coming months and decide if you should revise your strategy going forward. Set new goals based on what you achieved during the past month.
Did we spend more than planned?
Now it’s time to look at your expenses—both your cost of goods sold (COGS) and your operational expenses.
Similar to revenue, you should compare your expenses to your plan, last month, and the same month last year.
The questions you ask are also similar: are you staying on budget? Are expenses growing or shrinking? Are these changes O.K.? For example, if your sales are growing faster than planned, it’s likely that your expenses are also growing. This is probably fine, but worth keeping track of.
Like you did with revenue, consider your strategy, and plan going forward. Should you adjust your budget or keep things as they are? Set a task for yourself to revise if needed and then share that updated plan with anyone who is spending money in your business so that they can stay on track too.
Did our margins change?
After you’ve reviewed your expenses, take a few minutes to look at your gross margin. Your gross margin measures how much of each sale goes toward the cost of the products and services that you sell, otherwise known as the cost of goods sold.
If this number is shrinking, it means that your costs are going up and eating into your profits. Your overall costs could be going up because you are selling more of a product that costs you more to make or procure. Or maybe your suppliers are charging you more. Either way, if this number is growing, you’ll want to dig into the reasons why and take action.
If your gross margin is growing, congratulations! Your business is becoming more efficient and delivering more profit to the bottom line.
How profitable is our business?
This is the proverbial “bottom line” in your business. Again, you’ll want to compare this number to your plan, the previous period, and the same time period last year.
If you are more or less profitable than planned, you’ll want to dig into the reasons why. Did expenses go up and reduce profitability? Maybe sales declined, but expenses stayed fairly flat which would also reduce profitability. Look at your numbers and figure out why they are changing and come up with an action plan for changes going forward.
I sold more but why didn’t profits go up?
This is always an interesting problem that many businesses have. You sold more than you did last month, but profits stayed the same or perhaps even went down. How is that possible?
The first place to look is your operational expenses. Perhaps you spent more on marketing than you planned or you brought on some new employees and they helped generate additional sales, but not enough to account for the increases in payroll.
If the answer isn’t in your operational expenses, take a look at your cost of goods. It’s common for the answer to a profitability question to be hiding there.
As I discussed in the question about margins, you’ll want to look and see if your cost of goods and gross margin changed. Perhaps your sales increased because you sold more of a product that has a high cost, while other low-cost products or services didn’t sell as well.
Consider a bike shop as an example. Mountain bikes might have a pretty low margin — the shop only makes a small profit on each sale. On the other hand, the service department is very profitable. Every repair makes a big profit. So, if sales of mountain bikes increase while service revenue remains the same, the bike shop won’t make as much money as it did the previous month.
In this case, the bike shop might want to explore ideas for growing service revenue or perhaps consider increasing the price of its mountain bikes so that they are more profitable.
Make reviewing your income statement a regular occurrence
Doing an income statement analysis — comparing your key numbers to your plan as well as last month and last year — is extremely useful. It helps answer key questions about your business performance and how you can keep growing, building profits that you can reinvest into your business.
Build the habit of reviewing your budget compared to your actual performance and you will build a stronger, healthier business. Studies actually prove this — they show that goal setting and measuring progress toward those goals greatly increases your chances for success.
A monthly review of your business financials is invaluable and it doesn’t have to take a ton of time if you have the right tools available. Work with your accountant to make sure you can get the reports you need or use a simple tool like LivePlan to automate the entire process. Either way, take the time to look at your numbers so you can grow your business.
*Editor’s Note: This article was originally written in 2019 and updated for 2021.