What's an income statement and how do you use it?
What is an income statement?
An income statement is a financial document that shows your company’s income and expenses. Together with the balance sheet and the cash flow statement, it provides a detailed insight into the financial health of your business, including whether you’re making a profit or a loss.
Unlike a balance sheet, which records assets, liabilities and equities, an income statement focuses on revenue, gains, expenses and losses. This pinpoints your financial position against competitors and highlights potential areas for operational improvements.
What’s the purpose of an income statement?
Income statements provide valuable insight into your business's financial health. The report shows you where you're spending the most money and what generates the most revenue.
In addition to detailing your profitability to external stakeholders, it's also an excellent tool for assessing your internal operations. You can use it to decide how and where to expand, what sales tactics to keep using, and where to cut costs.
Generate income statements frequently — usually every month or every quarter — for a timely picture of your company's financial health. Additionally, you can review your spending over that period and change course as needed. Banks and other financial institutions will often ask to see a comprehensive income statement to assess your affordability for a loan.
Who looks at income statements?
Two groups of people look at income statements:
Internal users, like your management team, use the information to analyse your financial position and make data-driven decisions.
External users, like investors or competitors, use the information to assess your business' profitability and eligibility for funding.
What is on an income statement?
Revenue and gains
Operating revenue is your company's total income from its primary activity — the money you make directly from your advertised business. This will depend on your company type, but it can include income from selling products or providing services.
Non-operating revenue is the total income from activities that aren’t directly related to your primary business activity. This cash comes from other business activities outside your control, such as interest on business capital, rental income or royalty payments.
Gains refer to lump sums of cash made through non-operating business activities. While non-operating revenue is often consistent and ongoing gains are usually one-time events, such as money earned from selling fixed assets.
Expenses and losses
Cost of goods sold (COGS)
COGS refers to the total cost of making and selling your end product. It only includes charges directly related to your product or service, such as manufacturing, material and labour costs.
Selling, general and administrative (SG&A) expenses
SG&A expenses include the costs of all general expenses involved in selling your products or services. It usually consists of costs that you can’t attribute to the manufacturing and production of a product or the actual performance of the services you provide.
Depreciation is an accounting method that spreads the cost of a physical asset out over its lifetime. It highlights how much of an asset’s value you’ve used, which can help you lower your tax liability.
Amortisation is an accounting method similar to depreciation but applies to intangible assets like patents, trademarks and franchise agreements. It spreads out the intangible asset’s cost over that asset’s useful life.
Overhead costs are expenses that aren’t directly linked to your income-generating activities but play a part in supporting what you do. It includes office expenses like rent, insurance, supplies, travel, accounting and professional services.
Research & development (R&D)
R&D refers to the costs of innovating your products, testing new prototypes and training team members. It’s a vital part of your company's development process and future success.
How to use your income statement to calculate profit margins
Your profit margin is the difference between how much money you spend and how much revenue you generate. It provides an at-a-glance view of how well your company is doing financially.
Gross profit margin
Your gross profit margin refers to how much income you make for every dollar earned minus COGS. It doesn’t account for general expenses, taxes or overheads.
Use this formula to calculate your gross profit margin:
Gross Profit Margin = (Total Revenue - COGS) / Total Revenue
Operating profit margin
Your operating profit margin is your business's income minus COGS and general expenses. Look at your operating and gross profit margin side-by-side to see how much of your revenue goes towards expenses.
Use this formula to calculate your gross profit margin:
Operating Profit Margin = Operating Income / Total Revenue
Net profit margin
Your net profit margin is your total revenue minus COGS, general expenses, overheads and taxes. It tells you the company's total profit and is the key metric you should focus on increasing.
Use this formula to calculate your net profit margin:
Net Profit Margin = Net Income / Total Revenue
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Disclaimer: Information provided in this article is of a general nature and does not consider your personal situation. It does not constitute legal, financial, or other professional advice and should not be relied upon as a statement of law, policy or advice. You should consider whether this information is appropriate to your needs and, if necessary, seek independent advice. This information is only accurate at the time of publication. Although every effort has been made to verify the accuracy of the information contained on this webpage, MYOB disclaims, to the extent permitted by law, all liability for the information contained on this webpage or any loss or damage suffered by any person directly or indirectly through relying on this information.