This is the second installment in a blog series on small business finance. Read our first article on cash flow in your business here.
In the earliest stages of a new business, it’s natural to focus heavily on cash. Much like when living paycheck to paycheck, there’s a tendency to check your bank balance frequently to make sure there’s enough money to keep the doors open, the lights on and employees paid.
But once you've reached a more sustainable place, where you have enough cash to keep the business running, you can start looking at the money in your business with a different level of detail. You see things that happen monthly, seasonally, ups and downs in sales—things you won't see by looking at your checking account.
This is where your income statement, also known as a profit and loss statement (P&L), becomes a critical tool—not simply by having one and passing it to your CPA, but by understanding what it’s telling you. A P&L lets you look at the big picture, comparing one month, quarter or year to the next. It’s invaluable for showing your financial patterns over time—and every pattern tells a story about something happening in your business. Understanding what’s happening, what stories the patterns are telling you, is the only way to get money to flow predictably and consistently.
This probably isn’t the first time you’ve heard of a P&L. If you’re like most, you may feel like you can’t read it and think of it as a tool for your accountant. It is that and it’s a managerial tool—your tool. Learning how to analyze this financial statement will give you far greater control over the current and future profitability of your business.
The art of reading your income statement
Money is sensitive, so it’s a powerful key indicator for your business. Your actions show up quickly in either your expenses or your revenue. So if you look at money as a measuring stick for consistency in all the business areas, you’ll stand a better chance of targeting problems and creating more sustainability.
Building consistency starts with learning to read your income statement in a meaningful way. You can turn to your CPA for help with strategic decisions about how to account for your money and for determining how to set up an income statement and which categories you should include. But the way they’ll read it will be very different from the way you should be reading yours.
For you, the income statement’s real value lies in how you can use it as a heat map. Since the flow of money isn’t always predictable, an income statement can help you detect patterns and determine why changes to cash flow are happening. And if you see something that doesn’t match the pattern, it should be a flashing red light to you that something isn’t working the way it should be in the business.
If you notice that sales for last month far outpaced this month, ask yourself: Who would know why that’s happening? Go talk to your managers or salespeople to find out why last month’s sales were so much stronger. What you might find is that because October was a banger of a sales month, the sales team took a break in November.
In this instance, you’ve used the income statement to identify a problem: While you expect your people to deliver consistent results from month to month, your team is not aware of or aligned with that expectation. Armed with this knowledge, you’ll have more control over what’s happening and ideas for what direction to go in to begin to solve the problem, like asking yourself how to incentivize consistency so you’ll be better able to predict the business’s income and expenses from month to month. If the income statement hadn’t brought the issue to your attention, and if you hadn’t taken steps to get to the bottom of the discrepancy, that problem could have recurred again and again.
Here’s a simple exercise. Take out a copy of last month’s income statement, then get a blue pen and a red pen. Now review the items in your statement. If you see something alarming, circle it in red. If something isn’t performing how you want, circle it in blue. Ideally, you want to see your revenue going up and your expenses staying steady—but more often both are going up and down and not aligning. If you routinely do this exercise and start digging into the problematic patterns you see, soon you’ll get your finances into a more balanced rhythm.
Understanding your company’s key indicators is a crucial part of creating the business you imagine for your future. There’s a learning curve to understanding the nuances and deep value of your income statement that can be hard to understand without the help of a mentor or guide. If you’d like the support of an EMyth Coach, reach out to us. We’re here to help.