The income statement is important since it summarizes the company’s revenue in a given period. Also, it shows the amount of money spent to generate the revenue. The statement has several parts that include: the gross profit, operating expenses and net earnings. The importance of each part depend on the use the statement is to be put to. An investor interested in buying shares in the company will focus more on the earnings per share while a manager interested increasing return on investment will spend more time on the gross profit , the expenses incurred and the net earnings. The income statement makes it possible for the manager to compare his business and other ventures in the same industry. Here are the most critical parts of the income statement.
Gross Profit
This section shows the revenue generated from sale of goods or services minus the cost of the goods sold or the amount of money spent to acquire the goods sold. The section can help a businessman determine whether he is pricing the products correctly or not. It can also tell when he is giving too much discounts.
Operating Expenses
This section show how much it costs to run the business. The section caters for items such as salaries, cost of advertising, depreciation (Also see Depreciation and Impairment), rent, operating cost and the cost of utilities. It helps the manager to figure out the rate at which the expenses are rising. If they are rising faster than the gross profit, the manager should be able to single out areas that could be cut back without affecting sales.
Net Earnings
This section is important and shows the profit/loss the business made in a given period. It is important that you compare the current profit figures with the previous ones. If the trend is negative, one must find out why this is so. If it is a new business, compare the results with the expectations. Data on net earning can be used to calculate the net margin. Similarly, it can be used to calculate the net earning/ sales ratio.
Summary
As a businessman, it is important that you look at your revenue goal and compare it with your budget for expenses. A close scrutiny of the sections discussed can give insight into the problem at hand and possible solutions (Also see Common Accounting Mistakes Made By Small Businesses). When a comparison between changes in revenue vis-à-vis the cost from previous cycles is made, it can help to discover trends and could be used to stop and reverse dangerous trends such as a drop in the number of clients. It can also be used to encourage positive trends such as increasing the average sales. The income statement can then be used to calculate important financial ratios and plays a critical role in helping track key metrics and determine areas that require your immediate attention.
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