Understanding the Income Statement
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Alright, if you’ve been keeping up with my blog posts, you know we’ve covered a lot of the foundational bookkeeping items – why it’s important, what tools are the most helpful, and WHAT you should actually be doing.
Today, we’re going to take it a step further and talk about one of the end results of your bookkeeping efforts – reading the financial statements.
To start off, we’re going to focus on understanding the Income Statement. Maybe you’ve heard it called a Profit & Loss Statement, or P&L, but they all mean the same thing.
Understanding the Income Statement’s Purpose
The income statement shows a summary of all the money you earned & spent over a certain period of time. This is one of the primary reports you should be looking at each and every month to see how your boutique is performing.
This report will help you answer questions like..
“What were my total sales for the month?”
“What were my total expenses?
“Was I profitable last month?”
And so many more!
Understanding the Income Statement Layout
Your income statement will always have the same basic layout, no matter if you are a brick and mortar retailer, online only, or a mobile/pop-up boutique.
Just a quick note: I will be using some bookkeeping terms that I’ve previously introduced in past blog posts. The best one to refresh your memory is the one on Understanding the Chart of Accounts for Retail Businesses. You can read it again here.
Income Section
The top of your report will always be your Income section, and will include your gross sales, discounts, returns, and shipping income collected. At the bottom of this section there will be a subtotal that adds each of these items up. This total is known as your Total or Gross Sales.
Cost of Goods Sold
Immediately after your Income & Total Sales numbers, you will find your Cost of Goods Sold. Just a quick reminder, this is going to be the cost of the inventory that you just sold, just like the name suggests.
Gross Profit
If you take your Total Sales number, and subtract your Cost of Goods Sold, you get your Gross Profit.
One of the most common mistakes I see is business owners expensing the inventory when they PURCHASE it, which will inaccurately represent your Profit Margin, so you will have no way to know if you are truly pricing your products correctly.
Expenses
This section will likely be the longest section on your Income Statement. It lists out all the overhead expenses that you need to pay in order to keep your boutique running smoothly. Things like rent, utilities, employee wages, marketing costs, software, shipping supplies, and so much more
PRO TIP: If you want a copy of my boutique-specific chart of accounts that lists out the exact expenses I use to group my client’s expenses together, you can grab your template here.
Net Operating Income/Profit
If you subtract all your expenses from your Gross Profit number, you’ll find how much money you made (or lost) from your boutique in the day to day operations.
Other Income/Expenses
At the end of the report there may be a section that allows for “other” income and expenses. These are maybe funds that you received through interest in a savings account, or grant money you received.
They still need to be recorded, but they’re not really money you earned in the day to day operations. Instead of including these amounts in your Gross Sales number, it’s best to separate them out at the bottom so you can clearly see your boutique’s profitability based on your normal operations.
Net Profit – the “Bottom Line”
Finally, the very bottom number will add in any other income/expenses to your Net Operating Income to give you your Net Profit. If anyone ever wants to know what your “bottom line” is – this is the number they’re asking for.
Understanding the Income Statement: Three Things to Review
Now that you know what’s in an income statement, let’s talk about how to use it to make better decisions for your boutique:
Did I earn a profit?
Is your bottom line positive or negative? If it’s positive, you earned a profit. If it’s negative, you operated at a loss.
If you operated at a loss, you can start asking yourself questions about WHY that happened. Were your sales way down? Did you overpay for some advertising that didn’t provide the return you thought? Are you paying too many staff?
You may not know these answers right off the top of your head, but as you can see the data month after month, you might get some more clarity.
What is my profit margin?
One of the driving forces behind running a profitable business is having a strong profit margin. If you’re not charging enough for your products, you will never have enough to cover all your expenses.
To calculate your profit margin, you’ll take your Gross Profit and divide it by your Total Sales for the period, and multiply it by 100. Let’s take an example:
Let’s say you had $100,000 in Total Sales for the period, and your Cost of Goods Sold was $40,000. Your Gross Profit would be $60,000 ($100k – $40k). You would divide your Gross Profit by your Total Sales ($60,000 / $100,000) and you would get 0.6. Multiply that by 100 (.6 x 100) and you get 60%.
So what does that number ACTUALLY mean? It means that for every $1 you earn in sales, you have $0.60 available to pay your expenses. The other $0.40 is essentially set aside to replenish that inventory.
How does this month compare to prior periods?
One of my favorite things to do for clients is to look at how a current month’s numbers compare to the month prior, or even compare to the same month in a prior year.
The numbers tell a story. In today’s economy, it’s not uncommon for sales to be down when you compare November of this year to November of last year. But, it can be exciting and give you a little boost when you compare your sales from the holiday shopping in November to the summer slump in July.
Once you have more than one year of bookkeeping data to compare to, you can also start using your number to estimate what sales will look like next month, quarter, or year, and so you can use that to better plan out your inventory purchases.
It all starts with solid bookkeeping.
I hope you feel even just a little more confident in reading and understanding your income statement. Together, we reviewed the sections of the report, and we highlighted three main areas you should be reviewing and analyzing each and every month.
Remember, your income statement is like a financial roadmap. It shows you where you’ve been and can help you navigate where you’re going. Regularly reviewing your income statement will give you the insights you need to make informed decisions and grow your retail boutique.
So, grab your income statement, a cup of coffee, and start exploring your boutique’s financial journey. Let me know if you have any questions!
Here’s to finding your own version of freedom
Hi, I'm Megan!
Bookkeeping for the retail industry has some unique complexities that take extra time to manage to ensure accuracy. At Finding Freedom Financial Services, I provide done-for-you bookkeeping services for boutique owners that accurately track these complexities for you so you can have more time and focused energy to dedicate to running your stores. If you’re ready to get your time back, apply to work with me today!