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An income statement shows the revenue a company’s generated over a given period of time, (like for the year ended March 31, 2018, or for the three months ended April 30, 2018) and the expenses required to generate that revenue. Matching up the revenue to the resources (expenses) required to produce that revenue expresses the value the company has created for it’s shareholders’, it’s called net income.
On the first day of a company’s fiscal year, the net income of the company is moved to Retained Earnings on the Balance Sheet and the income statement starts again at zero. Because of this, the income statement is a periodic statement.
It also means its important to make sure you’re comparing the same period if you’re looking at multiple years. For example, you’ll have much larger numbers (theoretically) over the course of 12 months than over the course of 3.
It’s a good idea to look at your income statement monthly (which means your bookkeeping needs to be done at least monthly) to understand where you’re spending money. It’s easy to spend more than you on think in places you don’t realize. Like your phone, for example. What if you accidentally go way over your data one month and your bill doubles, but you’re setup for auto-billing so you don’t notice.
Or maybe you like to go to the local sandwich shop for lunch. It’s only $12 for a sandwich and a drink, which you think is totally worth it because it’s SO good, and you don’t have to make lunch for yourself. But is it? Assuming you work 6 days a week (because let’s be real, you rarely only work 5 days), that’s $72/week. By the end of the month you’ve spent $288 on sandwiches. Just sandwiches.
Your income statement also shows you the relationship between revenue and expenses. Some expenses should be the same (for the most part) regardless of the amount of revenue you generate. Like internet. It should cost the same amount for internet if you have 1 customer that month or 100. Now I don’t know about you, but if my internet expense suddenly doubled, I would really want to know why that happened, and preferably before I get charged that amount more than once. By looking at your income statement monthly, you’ll be able to see all of your expense in one place and investigate any oddities.
Some expenses are expected to increase as a direct result of an increase in revenue. Credit card processing fees is a good example because they’re a percentage of sales (i.e. 2.9% + 30¢ per transaction). Subcontractors are another example of a cost that usually directly relates to revenue. As you have more sales, you need your contractors to put in more hours, which increases your expenses.
This type of expense should be relatively the same as a percentage of revenue though. Divide your transaction fees by your revenue, is it about 3%? If it’s significantly higher, I would try to find out why. Are your subcontractors always about 40% of revenue? Did that number suddenly jump to 60%? Why? What happened to cause the jump? Maybe one of your customers required an extra 25 hours of contractor work this month but you can’t bill them until next month. In that case it might be ok because you know you’ll recover the cost, and the number will come back down next month. Maybe that’s not the case and one of your subcontractors had an error in their invoice. You’d want to catch that sooner rather than later.
Comparing expenses to revenues can be a bit tricky and overwhelming at first, but the more you do it the more meaning it will provide for you.. A good accountant can help you learn what’s normal for your specific company and industry, and glean insights we didn’t talk about here.
My point is this, if you’re checking your income statement monthly, you’ll begin to develop an expectation for what it should look like. If your numbers don’t meet your expectations, you can ask yourself why that happened. Doing so will always lead to information you wouldn’t otherwise have had.
If the idea of your income statement scares you, start small. Has revenue increased over last year? Have expenses as a whole gone up? Do you know why? As you get more familiar with the income statement you can start going deeper into the secrets it holds and getting more information to help you run your business.
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Kaitlin Kirk is a Chartered Professional Accountant who helps small business owners learn about their financial situation, work less, and get paid more. She used to do financial process improvement for a $5 billion company and now brings those big business skills and insights to small business owners. She spends a lot of time on the volleyball court and on-stage doing improv comedy when she’s not teaching small business owners how to decode their financial statements.