The Income Statement – Most Alluring Financial Statement of Them All
In a previous blog I discussed my favorite financial statement, the balance sheet. In that piece I mentioned that the income statement is the most alluring financial statement. Before discussing that I’d like to correct what I believe to be a misnomer. The other name for the income statement is the profit and loss statement. As accountants know, the end result (aka the “bottom line”) of an income statement is either a profit or a loss. Thus, the income statement should more accurately be called the profit or loss Statement. Let’s take a quick look at a generic income statement:
The main components of an income statement are:
Gross Revenue – total proceeds from the sale of a company’s products or service for a designated period of time
Less: Cost of Goods Sold – direct expenses associated with the relevant period’s sales
Equals: Gross Margin – percentage of revenue that exceeds the direct cost of items sold
Minus: Selling, General and Administrative Expenses – expenses associated with operations
Equals: Pre-tax Income
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Why do I consider the income statement so beautiful? Well, because it’s like a treasure trove of financial insights. With ratios derived from it, one unlocks critical metrics that reveal a company’s profitability, efficiency, and overall financial strength. There’s just so much to delve into, so much to analyze and so much actionable information to uncover. Who can resist such captivating beauty? Consider the following:
1. Top-line Revenue – is revenue up, down, or constant vs. a comparable period in the past?
2. Gross Profit Margin: (Gross profit/Net revenue) - indicates the percentage of revenue retained after deducting the cost of goods sold (COGS). Provides insight into the mix
3. Operating Profit Margin: (Operating Income/Revenue) - measures the percentage of revenue that remains after subtracting both COGS and operating expenses. Reveals operational efficiency.
4. Net Profit Margin: (Net Income/Revenue) - represents the percentage of revenue that translates into net profit after all expenses (including taxes). Comprehensive view of profitability.
5. Earnings Before Interest and Taxes (EBIT) Margin: (EBIT/Revenue) - measures the profitability of core operations before accounting for interest and taxes and depreciation. Helps compare profitability among companies with different capital structures.
6. Return on Assets (ROA): (Net Income/Avg. Total Assets) - evaluates a company's ability to generate profits from its assets.
7. Return on Equity (ROE): (Net Income/Avg. Shareholders' Equity) - measures a company's profitability relative to shareholders' equity.
8. Operating Expense Ratio: (Operating Expenses/Revenue) - measures the proportion of revenue consumed by operating expenses.
9. Interest Coverage Ratio: (Operating Income/Interest Expense) - evaluates a company's ability to cover its interest payments from operating earnings.
10. Last and definitely not least – looking at each of the S, G, and A expenses as a percentage of revenue indicates cost control success or areas for improvement.
In conclusion, the income statement is indeed the most alluring financial statement of them all, offering a tantalizing glimpse into the inner workings of your company’s financial performance. From top-line revenue to net profit margin, each component and ratio tells a story that can guide strategic decision-making and drive your business’ success. So, next time you’re diving into your financial reports, remember to give the income statement the appreciation it deserves – after all, who can resist such beauty in numbers?
At Breakaway, our advisors don’t just crunch numbers – we’re masterful storytellers of both the balance sheet and income statement. If your business is in need of a financial ally who can use your financials to develop a roadmap for success, reach out. We’d love to hear from you.