This Income Statement Example Explains Why Your Business is Profitable (Or Not)Posted by Celeste
Everyone is excited to look at an Income Statement (er…they are, right?)! But what are the most important things to look for when you’re reviewing your own income statement? Revenue? Profits? Something else? Let’s take a look at an Income Statement example to figure out what all of those numbers mean. Just click the image on the right to enlarge it, and let’s get going.
Sales on the Income Statement
In this Income Statement example, sales are broken down into two categories. Some income statements will have only a single line called Sales or Revenue, but some may break it out into more than one line – this line is important because it allows us to see how much money the customers are spending. In our example, you can see that for the Sunshine Ice Cream Co., total sales in 2013 were higher than in 2012. However, the Sales line doesn’t tell us whether the business had any profit – which is a much better indicator of a business’s financial health. A business can earn higher sales every year, but still dig itself into debt because its costs are higher than its sales – so let’s look a bit deeper.
Costs of Sales on the Income Statement
All the products you sell cost something to make – this is your cost of sales. In the case of this income statement example, the cost of ice cream is 35% of its sale price, but the cost of souvenirs is double that, at 70% of sales. Ice cream is clearly the higher margin item. (So let’s sell a lot of that!)
Gross Margins on the Income Statement
When you subtract the Cost of Sales from the Total Sales, you are left with the Gross margin. This is the amount of money from which all of the other bills will be paid before you can begin to think about profits. In our example, the good news is that the Gross margin has increased from one year to the next, even though the Cost of Sales also increased. In theory, this company should have an easier time paying its bills in 2013 than in previous years.
Gross Margin is a much better indicator of the financial health of a business, because it’s the “Real Revenue” – the money the company can take its profits from. Before that, though, the business has to pay its operating or fixed costs.
Operating Expenses on the Income Statement
Operating Expenses are often referred to as overhead, and rent and salaries are usually the largest expenses. Our example company’s wages went up by 50% in 2013. The company also spent more than double on advertising in 2013 compared to 2012. The overall expenses were considerably higher for 2013 than they were in 2012. But you have to spend money to make money, right? Maybe the company spent more on advertising to generate more sales – they did have a higher revenue year, didn’t they? And the extra wages? Perhaps the company owner got tired of working 14 hour days (it happens, you know) and hired an extra part time worker to allow her to have the odd Saturday off.
The Bottom Line
When it comes to Operating income (sometimes referred to as EBIT – Earnings before Interest and Taxes) we can see that despite having a stronger sales year, the company in our example ended up with lower profits in 2013 than it had in 2012.
An income statement tells the full story of how much money a company made and was able to keep in a given year, and how this changed over time. The top line is where a lot of people focus their attention – but you really want to be looking at your costs, and make sure they don’t increase faster than your revenue.
So here’s a challenge: go look at your last two years of income statements, if you’ve been in business that long. What was your Gross Margin and Operating Income? Are those numbers increasing, and if not, why not?