Basic Accounting:
Reading an Income Statement

Now that we've looked at a sample income statement and how to prepare one, let's look at how to read one.  Other than the obvious ingesting of numbers, we need to understand what those numbers tell us, and how to apply them to business plans, projected revenue, and profit and loss.

The first thing to ascertain is the frequency of the report you're reading: is it monthly, quarterly, or annual?  The most easily read statement is the monthly Income Statement.  Why?  Because the figures you are examining are monthly figures.  Since a business must operate profitability each month, if you are looking at an annual report, you are not able to determine if each month is profitable, or if only 2 out of 12 are profitable; cash flow and operating capital are necessary for the successful operations of a business on a day-to-day basis.  If you are profitable each month, and you are aware of the cost of goods sold each month versus sales, you can more accurately budget and plan for business operations on a day-to-day basis.

Questions that must be answered about a business, from a creditors and investors point of view: such as monthly expense in relation to income can be answered from the Income Statement.  Investors and creditors are often looking for the same information, just expecting a return from the business in different forms; creditors need a monthly repayment and investors would like a yearly dividend.   If you're interested in purchasing a business, wage, utility, rent and insurance expense are paid on a weekly or at least monthly basis.  Is the business profitable enough to cover these expenses each month?  The Income Statement is again able to answer those questions. 

Often, the miscellaneous expense of a business can hide important information.  Extremely high miscellaneous expenses that are reported on a continual basis should at some point be otherwise categorized.  You can review this on the Income Statement. 

Depreciation expense, prepaid expenses, and insurance expense are usually fluctuating and do not always directly affect the cash flow for the month.  Nonetheless, they must be accounted for, and will influence the profitability of the business.  Accurate recordkeeping and proper journalizing of the information will show up on the Income Statement.

When you're budgeting and preparing business plans of projected revenue and growth in the upcoming years, the previous years Income Statement, along with the other financial statements are crucial pieces of information, if you intend to put together an accurate and reliable budget and growth plan.  If you can start with reliable and accurate Income and expense figures, you can put together information that you and your employees can utilize each day in order to streamline business, and generate less wasted resources.  This increases the bottom line, or the net profit.  Once again, you should be able to see that the accounting cycle and the information produced is like a circle for a business, there is no beginning or end to the benefit of providing accurate, timely financial information when it comes to successfully assessing a business.

Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.