How to Read an Income Statement

This article will be of interest to you if you want to make your monthly financial statements more useful, if you want to increase your financial knowledge, or if you just want to give your accounting people something useful to do.

Phil’s Profit Points™ in Brief:

• There are five levels of income statement analysis.

• Level one: Did we make a profit?

• Level two: How do the results compare to last year?

• Level three: What are the trends we see this year vs. last year?

• Level four: How do the results stack up against our profit plan?

• Level five: What are the real business metrics: sales and production?

We’ve all heard that a picture is worth a thousand words. A good financial statement, in the hands of a professional, is worth ten thousand words because it tells a story about your business.

A good financial statement, one that you receive by the tenth or fifteenth of the month, does several things:

• It tells the story of where you are now and what happened.

• It identifies the good, improving, declining and poor results.

• It shows whether things are going to get better or worse if no one does anything different (hint, they usually get worse, and you might already be half-way through the next month).

• It allows you to hold your people accountable for performance.

Level one: Did you make a profit?

At the very least, your income statement should show a vertical percentage of all expenses as a percentage of total revenue, so they add up to 100%.

1. Did you generate a profit or a loss, how much, why?

2. Are you accruing amortization, corporate tax and loan payments each month so that the statements are accurate?

3. What are the gross profits by product or service line, customer or employee?
   

Level two: How do you compare to last year?

It’s reasonably useful to compare the individual month and the cumulative year-to-date financial results vs. the same periods last year.

1. Are the results better than last year?

2. Are revenues and profits moving in the same direction or opposite directions? Increasing revenues with decreasing profits is not sustainable.

3. Are we growing and getting better at sales, production and costs?

Level three: What are the trends compared to last year?

Looking at the numbers is an easy mathematical exercise. Figuring out the story behind the numbers is more difficult and more important.

1. What’s going on in your business and market compared to last year?

2. Why are revenues going up or down?

3. Why are profits going up or down?

Level four: How do the results compare to your profit plan?

Now, we are finally getting into serious financial and business management practices that will help you to accelerate your profits.

1. How do revenues and profits compare to plans?

2. Which marketing activities are most effective or least effective?

3. Which customers are growing and which are shrinking (paying slower, ordering less)?

Level five: What are the business metrics: sales and production?

This is the most powerful level because it ties your business activities and production results to your financial statements. The major problem with most off-the-shelf accounting systems is that they can’t report production numbers such as square feet or hours charged.

Production makes an ideal daily and weekly metric, by the way, that you can measure in real time and use to hold people accountable for results.

1. How much have you sold?

2. How big is the order queue?

3. How much did you produce last month? Is production increasing due to efficiencies, or decreasing due to errors (most common) or breakdowns?

4. What is the average price per unit, cost per unit, and margin per unit, and what are the trends?

5. Are the margins increasing or decreasing, and why?

Your income statement, also called the ‘P&L’ or ‘profit and loss’ statement, provides a wealth of information to help you run your business. That is, if it’s set up properly and if you are recording the correct information on a timely basis.

Announcing Remote Profit Mentoring™ and Profit Immersion™

If you run a small or mid-sized business and don’t have a full-time chief financial officer to interpret your financial results and give you proactive advice, we can help. We are excited to announce two new services.

Tough Question

Which level of income statement analysis do you presently perform? Which level do you need? How will you get there?

From the Piggy Bank

Accounting transactions, and financial statements, don’t create reality; they represent it.

Have a profitable week!