Editor’s Note: This is one of an eight-part series about key financial terms all business owners should know.
Chances are you’ve heard the word “Income Statement” at some point during your entrepreneurial journey. Maybe you’ve even reviewed one from your CPA or CFO (If so, bonus points!). But, if your eyes glaze over a bit when you hear the term. Or, if you’re not entirely sure how an income statement is different than a balance sheet. You’re in the right place.
What is an income statement?
It’s a financial report that shows a company’s financial performance over a specified period of time. Typically income statements are reported on a monthly, quarterly, or annual bases. However, a report can address any time period. An income statement shows revenues and expenses from operating and non-operating activities, along with net profit or loss. Income statements are sometimes referred to as “profit and loss statements.”
Why are Income Statements Important?
Income statements provide an easy-to-review report of your company’s performance over a period of time. Comparing multiple income statements for multiple periods of time can give you insight into how your business is doing overall. For example, if sales are up but expenses are up even more, your net profit may be down.
How can Income Statements Impact Financing Options?
Because they show performance over a period of time, many lenders use income statements to assess how a business’ sales and net income are changing over time. For this reason, many potential lenders require multiple income statements to review. They could potentially request three or more years’ worth, depending on the sum you’re financing or raising.
If you’re an entrepreneur exploring financing options, start reviewing your income statements. It’s best to review with your CPA or CFO, but if you don’t have one, use your accounting software to generate the monthly, quarterly, and annual reports now so you’re well-versed on your company’s financial health before you begin conversations with outside parties.
Ask An Expert
Bradley Klingsporn is a practicing CPA and Co-Founder/Co-Owner of Aardvark Wine Lounge in Green Bay, Wisconsin, so he knows a thing or two about why income statements are important to entrepreneurs.
Why is it important to have a handle on your income statement if you’re looking to raise capital?
Klingsporn: Not every company is a tech startup that can operate in the red for years and keep raising capital. Most businesses need to show profits or at least growth to convince investors to give you their money. Keeping close tabs on your income statement can help you know when it is a good time to raise capital and when it might be best to wait a few weeks if you expect some significant improvements.
What’s the biggest misunderstanding about income statements that you see from other entrepreneurs?
Klingsporn: Many small business owners have a difficult time differentiating regular ebbs and flows from trends. There is no hard and fast rule to determine whether a bad month is just a bad month or if it’s the start of a trend (the same can be true of good months). The income statement is a starting point that is used to begin understanding where the business is, but requires additional information to determine what that means for the future. For example, restaurants and bars will often see increased sales in months that have five weekends – to interpret these increases as growth could lead an owner to make capital improvements or hire additional staff that they may not be able to afford when the following month sees a decrease with only four weekends.
Give Me More
Just like it’s easier to travel in a foreign country when you know the language, it’s easier to raise capital (or secure any kind of funding for your business) when you’re familiar with key financial terms and their real-life applications. Want to get up to speed on your finances? Check out the other articles in this series which cover: turnover ratio, debt to income ratio, payables turnover ratio, debt service coverage ratio, current ratio, cash flow statements, and inventory turnover ratio.