In our most recent feature article, Pam Saul, CB of Saul Bookkeeping, takes us through an Income Statement (aka Profit & Loss Report/Statement), how to interpret it and how it can help your business grow!
How to Use an Income Statement
By Pam Saul, CB of Saul Bookkeeping
As a business owner, there are several instances where you may be required to provide financial documents to requesting entities. A bank, lender or investor, all may request financials for your business. They will all likely want to see your Income Statement, also known as a Profit & Loss Statement (P&L). And unless you have a CPA or CB behind your name, it’s more than likely no one has ever told you WHAT information this document gives you!
Here, I will break it down into manageable pieces and go into detail to help you understand what this report is and how it can help.
First, let’s review what information is recorded in this document. The P&L records information for a specific period of time. You can choose – it’s typically monthly, quarterly or annually. It’s also possible to create a custom time period or create comparison reports that show different time periods side by side. If you use a software system like QuickBooks, your computer can create these reports for you.
The information within the report shows revenue/income and expenses broken into sections. The top section outlines the income and the total of all this income gives you the Gross Profit or total for the period. The bottom section shows the expenses for the same period. This section also has a total. At the very bottom of the report, a calculation is done: income minus expenses equal Net Income (or loss). Here is an example of a very simple Profit & Loss report showing these labels.
In this case, for the period of January, there was less income than expenses, so the business shows a net loss for the month. The report shows the loss as a negative number.
Some companies use a more detailed bookkeeping system that records Cost of Goods Sold (COGS). These are still expenses but are considered direct expenses against the product created. It includes the cost of materials and labor that are used to create the goods.
An example would be a company that manufactures bikes. COGS would be the materials and parts that go into making the bike, plus the direct labor used to put the bikes together. Costs associated with selling the bikes wouldn’t be included in COGS.
Here is an example of a Consulting Business that uses COGS. For this business, the payroll for staff and outside consultants are costs applied directly against the revenue (since they don’t have a product.) The balance of the COGS deducted is how to calculate the gross profit.
Other expenses outside of COGS are considered “Overhead,” meaning they aren’t directly related to the production of the service or product. Overhead are those things that are related to running a business and are considered normal expenses, such as insurance, rent, office supplies, telephone, utilities, etc. These are listed after the COGS as a separate subset of expenses on the P&L report. You can see that after Total Expenses, the report shows the Net Ordinary Income.
And lastly, any income/expense, that is not part of the normal course of business, shows as Other Income or Expense. Most recently, the PPP Loan program with its forgiveness of the loan amount would show here. Rebates on credit cards would also be here.
The bottom line shows your final amount with all accounted for as the Net Income or Net Loss.
Now that we’ve identified the parts of the P&L, let’s talk about how to use it as a tool for your business.
· If you launch a marketing or advertising campaign, you can run an Income Statement by week to see how it is progressing.
· If your business has a season, run a quarterly report that matches to see how you are doing. Remember that your fiscal year doesn’t have to follow the calendar year. So a quarterly report can be for any 3 month period you want to use. A farmer’s market could use June, July and August, while a tutoring business could use the school year as their framework.
· A yearly report can show you how you did for tax purposes. You can run a report that compares previous years so that you can see how you are doing in comparison. This is a great report for new businesses that want to see how things are progressing from year to year.
· You can run reports by job, project, class, or location. These can help you see details that can help you recognize which is the most cost effective or profitable service. It can also highlight something that isn’t working and give you the ability to see it in numbers!
There are several other tools you can use with a Profit & Loss for budgeting, “What If” scenarios, your business performance, your gains and losses, and the ability to analyze how efficiently your business is running. These are all things that Saul Bookkeeping can help you with. Our aim is to help you use your bookkeeping tools to run your business in the best possible manner!