How an Income Statement Measures Performance
An income statement is one of the many financial tools that Canadian entrepreneurs can use to measure profitability. Learn how to use an income statement to evaluate your business’ sustainability.
What is an income statement?
A calculation of a company’s revenue and sales less its expenses over a designated period of time.
What profitability measurements does an income statement include?
The income statement starts with revenue/sales less direct costs and operating expenses resulting in the net income at the bottom of the income statement.
1. Gross Profit
The revenue/sales generated by the business minus the costs directly associated with the goods and services sold.
- First section of the income statement shows the gross profit after direct costs
- Amount the company generates before operating expenses and taxes
- Gross profit doesn’t include operating expenses such as administrative salaries or expenses or supplies that are not directly tied to production.
2. Gross Profit Margin
The gross profit divided by revenue/sales
- May be expressed as a percentage or on a per unit basis i.e. the selling price of a product less the costs to produce it
- Demonstrates efficiency
- How well does the company manage expenses?
- Are goods and services appropriately priced to offset associated costs?
- Can you better manage costs to grow the gross profit?
- Can selling prices be adjusted to increase profits?
3. Operating Profit
The gross profit minus fixed and variable operating costs of running the business (over and above those costs directly tied to production)
- Administrative and selling wages, office rent, commissions, professional fees
- One-time costs are not included
- More accurate picture of profitability
4. Operating Margin
- Operating income divided by revenue/sales
- Demonstrates how your operations (/operational-improvement/) are affecting your profitability
- Are operations efficient?
- Are they reasonable when compared to the revenue/sales they generate?
5. Net Profit
The “bottom line” or end-point of the income statement.
- Represents a company’s total net earnings
- Revenue/sales less all direct and operating expenses associated with conducting business
- Includes all expenses:
- One-time costs
- Internet expenses
- One-time costs (especially large purchases) may result in a net loss. However, this is not a strong indicator of the company’s capacity to generate profit over the long term
6. Net Profit Margin
Net income divided by revenue/sales
- A continuous upward trend over a few years is a reliable indicator of profitability
Learning how to use an income statement to increase profitability requires more than just knowledge of what each element within the statement indicates. More than accurately calculating whether the business generates profits, entrepreneurs need to understand why this has happened and what it indicates about the sustainability of their business model.
An income statement is actionable and should enable business owners to take the necessary steps to improve margins. If you have any questions about building an accurate reflection of your financial situation or how you can improve operations to grow profit margins, contact the accounting professionals at Hogg, Shain & Scheck today.