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.
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.
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
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?
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
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?
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 (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
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 us today.