Last week we got a better understanding of what an income statement is, now it’s time to take a deeper look and see how we can use this very practical tool to grow your business.
So your accountant closes the books for last month and sends you over the income statement, what do you do? (Check out my post from last week titled Who Cares About an Income Statement? if you need to first gain a better understanding of what the income statement is.)
At this point you know what revenue is, what expenses are, and how they are presented on the income statement. Let’s now take a look at some basic things to look for.
Things to Look For
The first line of the income statement will always be revenue or sales. Two things to look at right away are how you are projecting for the year and how this month was compared to the last few months. This will give you a good idea of where you are and where you are headed.
Next, I usually take a quick scan through each line item and give it the “sniff” test. I am sure you have a good handle on your business so you will know right away if something doesn’t look right. For example, let’s say your monthly rent is $1,000 but last month it shows $5,000. Clearly this isn’t right unless you moved your office. Make a note of everything that doesn’t make sense and discuss with your accountant.
At this point you should have a pretty good idea of where you are at. However, there are two go-to tools that I use rigorously to gather additional information. The income statement can paint a very clear picture of the state of your business, but these two tools are going to help make your financial picture crystal clear.
Trend analysis looks at all the revenue and expenses over a period of time, say monthly. You can then see trends of certain expenses going up or maybe revenue declining. My favorite report for trend analysis is a side by side monthly income statement. You should learn to study this report and ask questions. Why did advertising expenses double in May as opposed to the rest of the year? Why is our salary expense rising every month? Why is revenue steady throughout the year but falls off in November? These are some of the questions that trend analysis can help bring to the surface. This tool helps us ask questions, and we can’t get answers if we don’t know what questions to ask.
Net Profit Margin
Net profit margin is probably the most telling ratio for the income statement. It is basically what % of income is being taken to the bottom line. Here is how to calculate it…
Net income / Revenue = Net Profit Margin
Every business and industry is different so there is no magic number you need to attain. However, it does make sense to compare your margin to others in your industry to see how you are doing. You can find these statistics all over the internet. Net Profit Margin really is one of the best ways to measure the success of your business.
There are many other analysis tools that can help business owners make decisions, such as gross margin percentage, EBITDA, return on equity, etc. It is imperative to obtain the relevant ratios and/or analysis for your industry from your accountant to aid in current and future decision-making. I’ve already shone you a few tools and the rest is up to you. Sit down with your accountant this week and ask him or her how you can be more aware of your own business.