The owner of a $100-million company recently told me he wasn’t sure he understood his financial statements. How could someone build a successful business in less than five years while not understanding how to read a financial statement?
Because he’s good at hiring great people, including his chief financial officer (CFO), and has other skills, he hadn’t spent the time or been taught how to read his statements.
Many business leaders feel overwhelmed when reading financial statements. They shouldn’t be. Here’s what to look for on your income statement to help you feel more confident.
Understanding what an income statement is
Income statements are sometimes called profit and loss statements for a good reason. They tell you how your business is doing over a period.
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Ask for comparative statements: Always ask your bookkeeper to provide you with comparative statements. Looking at one income statement by itself can be misleading. A comparative statement means you have two income statements on one page: this year’s and last year’s. The periods should be the same so you can compare apples to apples.
You will also want to look at your year-to-date (YTD) income statement, which will help you understand how you’re doing over a longer period. Again, ask for a comparative statement so you can see how you’re doing compared to last year.
Income statements are broken into three sections
The first section is the revenue statement, which shows where your income comes from. It might be broken down into departments or divisions to enable you to see where the money is coming from. It also shows your cost of goods and how much gross profit you’ve made. Gross profit is the money you have before your expenses.
- Revenue: You want to look at these and ask: Are sales increasing or decreasing? By what percentage? Are certain departments growing or declining compared to the previous period? Why is that happening? What are the trends in the business? Are you doing anything differently that’s helping or hurting sales? Why are certain areas outperforming others? The more you can figure this out, the better your chance of success.
- Cost of goods sold: Look at each line on your income statement. What has changed from the previous period? Can you explain the changes? Is there any input cost you can reduce? Have the costs of goods increased or decreased?
- Gross profit: Look at the gross profit percentage compared to the previous period. Has it gone up or down? If the gross profit has gone down, you may need to make changes to ensure this doesn’t continue. What needs to be done? If it’s going up, good for you. Consider what you’ve done to make this happen. Can you continue to do this?
The second section is the expenses, typically a list of different types of expenses. These might include rent, labour, administration, insurance, utilities, etc.
General and administrative expenses: Carefully compare this area line by line to the previous period. Are there expenses that have gone up? Why have they gone up? What needs to change? Are there areas where you can eliminate more costs? Remember that every unnecessary cost you can reduce goes directly into your pocket as an owner.
Profit or loss: The last part of the income statement tells you if you made or lost money. Compare your profit in this period to the previous period. Are you going in the right direction? Have you hit your goal for your profit? Are you happy with this number or discouraged? What needs to happen for you to reach your goals?
Remember, you own the business to make a profit.
Don’t rely on the bank balance
Many small business owners base their important decisions on what’s in the bank on any given day. This is problematic. You’re asking for trouble if you don’t know where you’re coming from, where you’re going or how well your business is doing. It’s like driving a car without a gas gauge or a sports team not finding out until the end of the season if they’ve won or lost games. You wouldn’t play sports or games without keeping score. Why play roulette with your business by not keeping score?
We need to get beyond the fear of looking at our financial statements. Once we know what we’re looking for and understand how we can make the changes we need, our monthly comparative financial statements should be something we look forward to reading.
Dave Fuller, MBA, is an award-winning business coach and a partner with Pivotleader Inc.
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