Understanding an Income Statement

An income statement is one of the three essential financial statements that a business owner uses to keep an eye on their success. It summarizes the company’s revenues and expenses over a specific period of time.

Understanding Income Statements

Also known as a profit and loss statement, an income statement will show you how your “bottom line” is doing — that is, whether you made a profit or took a loss during that timeframe.

If you are buying a business, understanding the income statement will give you a good idea of the financial health of the company and show you how overall sales, costs, and profitability look.

Sales Revenue

The very top line of an income statement will show you the gross sales revenue for the period. That’s the raw dollar amount of sales without any expenses removed. Gross revenue is a good starting point because it shows you how much room you have to grow or improve profitability.

Low revenues might mean that the business owner hasn’t taken full advantage of the market. That could indicate a lot of growth opportunities, but you want to make sure you fully understand why the current owner hasn’t grown the business, so you’re aware of obstacles.

High revenues often mean that you have great opportunities for profitability if you control costs. If you notice that you could improve the business processes, that’s a good sign. However, be sure to do your due diligence into any roadblocks that could keep you from implementing the changes, such as uncooperative senior management.

Cost of Goods Sold and Expenses

If the company sells physical products, there will be a line showing the cost to produce the goods. The cost of goods sold (COGS) is the first deduction from gross revenue. Revenue after the COGS is the gross income or gross profit.

The gross profit helps you understand how efficient the business is in producing goods. However, it doesn’t include overhead.

After gross profit, you’ll see line item expenses showing the operating expense during that reporting period. You’ll see recurring expenses such as rent, marketing, and equipment upkeep. These operating costs will reduce the gross profit figure down to the operating income or operating profit.
Operating profit will let you know how the company fares after all internal costs are deducted. These are the costs that you, as a business owner, have direct control over.

Pre-Tax and Post-Tax Profits

The final portion of the income statement will show you the pre-tax and post-tax profit.

Most businesses have loans and are paying interest on those loans. The interest expense is deducted from the operating profit to give you the pre-tax profit. Finally, taxes are removed to provide you with the net income, which people refer to when they talk about “the bottom line.”

To get an accurate feel for the profitability of a business you’re interested in buying, make sure you look at several income statements. Is the company showing an upward trend? Are costs under control? Are there any expenses that seem out of line for the industry?

Knowing whether you can make a profit right away or will have to rescue a company from excessive costs and inefficiencies can help you decide what price to offer — or if you want to buy the business at all.

Know Your Income Statements

Reviewing income statements is just one of the essential aspects of due diligence. You also need to see other financial information, such as the cash flow statement and balance sheet. You’ll need to understand the industry and how the business is perceived in its local market.

Finding the right business to buy is a lot of work. Fortunately, Murphy Business can help. We know how to match buyers with the right opportunities and help you find a business that fits your needs.

Contact us or find a local office today to learn more!