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 Understand your income statement 

The former Mayor of New York City was often quoted saying "How’m I Doin’?". This is exactly what an Income Statement responds to. The Income Statement answers the main questions you would wonder about a business: Am I making money or not ? and if so how much ?

Wall Street values a good income statement

The Income Statement is probably the easiest part of the financial statements to understand. At the top is your income followed by expenses the difference is the bottom line. If that bottom line (the amount at the bottom with the double line underneath ) is positive you made money !

So what could confuse you about an Income Statement ? (other than the fact that some people call it a Profit & Loss ). The following are some terms that you may find that are not familiar:

Cost of goods sold - This are the costs directly related to your making or acquiring your products. Let’s say you manufacture tennis shoes then the materials and labor used to manufacture those shoes would be cost of goods sold. Overhead that relates to the general operation of your business or sales of products should not be in this section.

Gross Profit – This is you sales less your costs of goods sold. Why would you care about your gross profit if it does not include all expenses ? Because it can help predict at different sales volume whether the business will be profitable or not.

Depreciation – This is an expense that attempts to show the loss in value over time of assets that your business owns. If you bought a truck in a particular year it has most of its value at the end of the year. So it would be unfair to record the entire expense in the first year. So depreciation is taken at specific percentages of the total asset’s cost over the life of the asset.

As simple as all this sounds there is a good reason why smart business owners will ask an accountant to help them interpret their Income Statement. The best reason is because there are ratios and methods of analysis that may tell a different story than what you think you are reading. Sometimes a business may be profitable but does not have the cash flow to survive its needs in the near future. If you are considering buying or selling a business it makes sense to make have a professional read and explain the financial statements you are reading.

One should also understand that the income statement is only one part of a set of financial statements. So if you do not look at the balance sheet and statement of cash flows it is possible that you are missing essential information to analyze the business you are looking at.