As a small business owner or entrepreneur, your business is your livelihood. Monitoring the financial health of your business is essential. It’s common for small business owners to focus on the cash flow statement, since that’s something they need to consider on a daily basis to pay overhead expenses. But if you’re ignoring other reports, you may not have a clear understanding of your true financial position.
What Is an Income Statement?
An income statement is one of three major financial statements that small businesses prepare to report on their financial performance. Income statements, balance sheets and the cash flow statements are essential tools for business owners. These three reports are often confused so here is a brief definition of each.
- Income statements (also called profit and loss statements) show how profitable a business is over a specific period of time. If a business’s revenues are greater than its expenses, the income statement shows a net profit. Otherwise, a net loss is shown. Simply put, it shows whether or not a business has profited over a specific time period.
- A balance sheet reports on your business assets, liabilities and owner’s equity. Assets are things you own including cash, bank accounts, accounts receivable, and inventory. Liabilities are things you owe, including accounts payable, taxes, and loans.
- Cash flow statements record the amount of actual money that flows in and out of a business. It details how business operations are running, where the money is coming from, and how it is spent. This report shows how well (or how poorly) cash flow is being managed.
Why Are Income Statements Important?
An income statement records all revenues and expenses for a business during a specific time period. You can create an income statement on a monthly, quarterly or annual basis.
While income statements are often required by law for accounting purposes, they also provide essential information for business owners. An income statement is a tool for improving your finances. Income statements are important for any business because they:
- Show Financial Trends
An income statement can quickly establish how well or poorly a business is doing financially and whether or not it’s profitable. By analyzing income statements over time and comparing them, you can understand how well a business is doing in relation to its expected performance, and use that understanding to make adjustments. For example, a business owner whose company misses sales targets one quarter might develop strategies to improve sales in the next quarter.
- Help You Get Financing or Lines of Credit
Income statements, along with balance sheets, are the most basic elements required by potential lenders and investors. Banks and other financial institutions will require them before signing off on a loan.
Lenders use the financial reporting contained in these documents to determine whether or not to loan money and establish credit limits. If you’re seeking financing from investors, you will need to provide an income statement to prove your company is profitable or has the potential to become profitable.
- Improve Decision Making and Planning
Income statements help business owners determine if their company is trending toward profitability or losses. Because an income statement thoroughly lays out income and expenses, business owners can identify where changes need to be made to increase revenues or cut expenses.
Analyzing income statements can help you determine if you can afford to hire new employees, move to a bigger location, or determine whether your current growth strategy is effective.
- Ensure Tax Compliance
A small business and its owner are subject to a variety of local, state, and federal taxes. You need accurate records to prepare tax filings and remain in compliance with tax regulations.
These records must document the income, expenses, and credits you report. Accurate and up-to-date income statements give a business owner the information they need to calculate taxes and take advantage of available tax credits and deductions.
Get Professional Help to Understand Your Income Statement
Your income statement is more than just numbers your accounting software turns out. Learning how to read and understand your income statement will help you make informed decisions that impact your short and long-term financial goals.
Working with an experienced business accountant on a regular basis to analyze your financial statements will help you determine how to improve your profitability, reduce expenses, and take advantage of tax planning strategies.
Orcutt & Company is a full-service financial solutions provider. Our comprehensive service plans are designed with the small business owner in mind.
We can handle your bookkeeping, payroll, corporate and personal taxes in one office, with one point of contact. Our integrated approach is designed to ensure that we understand your personal goals and how they integrate with your business finances. Consultation is fundamental to all our business services. Through our annual review with owners, we look at tax projection, the status of the business and more.