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How to Read Your Income Statement

Author: Becca Jones

Every business owner, at the end of every month, receives an income statement and balance sheet. These two documents can be the most confusing pieces of paper to understand—if you’re not used to looking at them.

So, let’s take a brief look at what’s really important for you to look at on these documents.

Better yet, we have Larry Chester, President of CFO Simplified to explain things. Here’s how to make sense of the mirage of numbers on an income statement and balance sheet.

The Four Most Important Figures to Look At

There are four key numbers you need to take a look at.

  • Sales
  • Gross margin
  • Operating expenses
  • Net income

And what’s important about each of these numbers? How can you look at these so they are meaningful?

Sales

Sales, of course, tells you whether your business is growing or not growing.

If you’re looking at sales, it’s important to look from the perspective of, “What is selling?” It’s not just a matter of whether or not you have sales that are better than previous months. The key is asking yourself, “Are there particular product groups you have that are selling more than they sold in the past?”

Gross Margin

Gross margin tells you what you’re making on the products that you’re selling.

You want to look at gross margin with the same approach as sales. For each product family that you have, identify what the items are that you’re selling. (Pro-tip: Look down even further in a subsidiary report to look at the individual items that you’re selling within those product groups).

Ask yourself: “What are the items that are giving us the most bang for our buck? What is the biggest profit that we have?”

If you’re spending most of your time concentrating on sales for an item that’s only getting a 5% gross margin, and you have other items that you’re earning a 35% gross margin on (but are not promoting them), it’s likely you’re putting your money in the wrong place.

Operating Expenses

Operating expenses are your fixed costs like rent, utilities, and payroll.

Net Income

Net income is the money you put in your pocket and take home at the end of the month.

How to Read Your Income Statement

The Importance of Trends

The next thing to take a look at is your trends.

You want to identify how sales are moving, and whether those sales are going up or going down.

Larry Chester of CFO Simplified describes a pivotal moment for one of his clients. “I had a client who had seven products that he was selling on a regular basis,” says Chester. “Only two of them were growing, but they were growing so fast and making so much money that they obscured the loss of income and the loss of sales that he had in the other five products.”

So, take a look at that trend analysis to determine what’s happening. After all, why waste resources on things that are not performing? Or, why not take the time to improve those things so that they are performing for you?

Management by Exception

Lastly, take a look at management by exception.

Management by exception (MBE) is “a style of business management that focuses on identifying and handling cases that deviate from the norm.”

Let’s paint a picture of management by exception: If you’re taking a look at numbers over a period of time, and there’s one number that spikes up in a particular month, you might ask yourself, “Why did it do that?” “Is this a good thing or a bad thing?” “Do we want to keep that from happening in the future, or do we want to ensure it happens every month?”

These are decisions that you have to make as a business owner, however, you cannot take this information (that spike) and look at it in a vacuum of one individual month.

Management by exception encourages you to look at these occurrences over a period of time.

Larry Chester, personally, likes to look at a rolling 12 months. Simply because beginning to look at the start of the year, at just a month or two, doesn’t tell you much. Looking at a 12 month period, on the other hand, makes it easier to find the exceptions. They will stick out like a sore thumb.

A Final Word

Although your income statement can be a valuable document, oftentimes, business owners aren’t able to simply look at it and get a handle on the overall performance of their business. Instead, they’re drowning in granular data.

Hopefully, the above tips helped!

So, all in all, take a look at your percentages, your trend analysis, and at management by exception. Then, that big morass of numbers that once held no meaning to you, will suddenly be shining like a light at the end of the tunnel.

An outsourced CFO, like those who work at CFO Simplified, can help get your financials on track. Read on to learn how CFOs add value to your business as well as what we look for when hiring CFOs at CFO Simplified.

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