Small business owners do not have time to deeply dissect financial statements. Luckily, interpreting the income statement requires just a simple analysis of its key elements: Revenue, COGS, Opex, and Income. Here’s a breakdown of the elements and some questions to consider for analysis:
The revenue section of the income statement shows the company’s ability to monetize its customers. To interpret revenue, ask the following questions:
- Do sales come from a diverse array of products and services, or just one specialty?
- Are multiple sales channels apparent in the revenues, such as wholesale, retail, and e-commerce?
- What is the distribution of sales across these channels?
- Is the business concentrated within one channel or product?
Interpreting Cost of Goods Sold (COGS)
COGS represents the direct costs associated with producing or delivering goods or services. Questions to ask when analyzing COGS include:
- Are my costs weighted more heavily towards raw materials, labor, overhead, or other expenses like shipping and payment processing?
- Are my gross margins consistent with industry standards or the company’s historical performance?
- Are there any significant recent changes in COGS? If yes, what factors contributed to these changes?
- Are my variances consistently high or unpredictable, indicating poor process control or cost accounting?
Interpreting Operating Expenses
Operating expenses are incurred while running the day-to-day operations of a business. Questions to ask yourself when analyzing operating expenses include:
- Are the operating expenses well-controlled, consistent, and in line with expectations?
- Are there any significant recent changes in operating expenses? What is driving those changes?
Interpreting Net Income
Net income is the bottom-line profit after accounting for all costs and expenses, including interest, taxes, and non-operating items. Questions to ask yourself when analyzing your net income include:
- How does the net income compare to previous periods? Is it consistent or showing a significant change?
- Are there any extraordinary or non-recurring items affecting net income?
- Is net income hitting or beating budget?
Interpreting all financial statements
The income statement is just one of three critical financial reports – the others being the balance sheet and the statement of cash flows. Once you understand each of these reports individually, check out our guide on the interpreting the income statement and cash flows together to develop powerful analytic skills and business judgement.