Why is the Income Statement important?
In this lesson we’ll be talking about the income statement and why it is so important to prepare one for your online business. Let’s begin with a brief explanation.
What is an income statement?
It is basically a detailed record of the income earned and expenses incurred by your business during a certain period of time. This can greatly help you gauge how well it is performing, especially when it comes to generating revenue. Additionally, it helps you forecast how well it is expected to perform this way in the future.
Structure of an income statement
What an income statement basically does is summarize the results of all business operations during a given time period into two broad categories: the income earned and the expenses incurred in the course of running a business to earn that income.
Under these two categories the statement broadly lists out the net sales, gross profit, cost of goods sold, selling expenses and most importantly, net profit of your business.
What is it generally used for?
The income statement is commonly used to validate the business’ net worth and determine its share price for potential investors. It is also your go-to statement for getting a fairly accurate idea of the profits your business is making.
In other words, the income statement provides you a clear-cut picture of your online venture’s income, expenses and profitability. This is why it is used as a basis for determining the total profit gained or loss borne by your business during the given accounting period which could be a year, a month, or a quarter.
Expenditure to revenue
A key benefit of the income statement is that it helps you see how much of your expenditure is translated into revenue. In other words, you get a fair idea of how well your business is able to turn expenses into profits.
It also helps you decide if your business is capable of generating profit in the long term. This can influence certain important decisions such as investing in new equipment, hiring additional staff etc.
Why is the income statement important for ecommerce businesses?
The main purpose of any income statement, especially for online businesses is to give the business owners, investors, lenders and creditors an idea of whether or not the company is profitable during the given period.
So the most important reason why your ecommerce business needs to regularly prepare income statements is because it indicates your ability to make a profit. Getting this right can help you show your company’s financial health, which can help you attract funds and financing from investors.
It is also regularly used by business owners to know if their periodical sales targets are being met and can further help identify any shortcomings in strategy.
How exactly does the income statement help me get financed?
The income statement reflects the business performance during the given period to the investors and owners. The net profit earned compared to expenses help determine your business’ overall net worth. If your results are promising, it shows in the report.
Key reasons why you need an income statement
Helps in evaluating performance
If your sales are suffering or if you’re running a little low on profit, it will show on your income statement. By helping you compare your financial progress for each term regularly, the statement helps you evaluate whether your business is performing up to expectations.
It also helps you notice a lot of hidden expenses that aren’t self evident in the course of running the business.
Summarises your activities
All the listed revenues and expenses actually give you a brief and quick overview of all the activities and operations you’ve undertaken in the course of business and the progress achieved.
Helps attract investors
The income statement gives buyers, stakeholders and lenders a basis to evaluate whether or not finding your business is a good idea. This is why potential investors are definitely going to be interested in reviewing your income statement when they consider your proposal.
Aids you in decision-making
With all the essential data on sales, profits and expenses made easily accessible from time to time, you can make better, more grounded decisions for your business.
Instead of relying on intuition and incorrect assumptions, your approach will be based on facts and figures that offer a realistic view of your business.
A lot of the major decisions you need to make such as increasing production or supply, adding to your marketing budget, expanding to target a new audience etc can all be considered based on this highly significant statement.
If you’re running an even moderately successful business online, you’re inevitably going to have to pay various
taxes. The financial statement helps you assess and ascertain what tax liabilities your business has and aids you in calculating them.
Your income statement gives you a clear picture of whether or not your business is capable of making good returns.
If you’re able to show that you can make good returns in the long run, Investors will be far more interested and see your business as a valid opportunity. The profit and loss statement helps you achieve that.
Keeps you updated on activities
An income statement includes both operational and non operational expenses. When the statement is regularly reviewed, any issues or problems on the operational side of the business can be easily noticed and fixed.
Clarifies revenue and expenses
The income statement largely helps your business clarify what your returns are and what your expenses are.
In addition to revenue from sales and other business income, you will also be able to view the returns generated from non business avenues such as investments.
It also reflects the rate of sales as much as your profit. This can also point to other areas in which your business can improve.
Investors can also get a good grasp of your financial status by focusing on business revenues and investment returns separately.
Keeps track of overhead expenses
By classifying revenue and expenditure in a clear manner, you’re able to track which expenses are growing, how much they’re costing your business and whether you need to cut any of them out.
Basis for comparison
Your income statement also allows you to properly compare your financial growth and progress periodically, from quarter to quarter and year to year.
In other words, you can track how well you’re doing by comparing past performance with the present. In addition to that, you are also able to compare it with competing businesses.
As we’ve already discussed in overview of financial modelling, the income statement is essential for forecasting the future growth of your business. It greatly aids in revenue projections based on past trends.
It is also widely used by equity researchers and analysts to forecast, evaluate and predict the future performance of your company. Important ratios such as the Ebitda margin, interest coverage and more help you achieve that.
In other words, it has a broad application and is heavily relied across the board for a variety of purposes.
Now let’s take a look at how the income statement is important to different roleplayers in the business:
Business Owner (You)
The statement gives business owners a very clear picture of how well the current strategy is working and also insights into how it can be improved.
The income statement serves the purpose of providing investors a source of analysis so that they can decide whether it would be wise to invest in your business. Your progress and profitability will be reflected in the statement which helps them decide the rate at which the business is likely to yield returns and what stake they are willing to invest.
Getting financial institutions and other lenders to grant you a loan is much easier when you have a periodically prepared income statement to back up your claims. It is a record that helps you convince potential financiers to lend funds for you to scale up your business. It is a huge factor that shows them your creditworthiness based on the profits your business is making.
Creditors or suppliers
Creditors and suppliers are parties that provide you with the services and products you need to run your business. If your online store outsources products wholesale or partially, then a sound income statement can help add legitimacy to your business. It also indicates whether you can make good on your short-term liabilities.
These are all some of the key reasons why the income statement is highly important for your online business. In the upcoming lesson, we’ll be exploring the various revenues and expenses that fall under the income statement.