In my last article I discussed how to review your Statement of Cash Flows. Today we’ll look at your Income Statement, also known as your Profit & Loss (P&L) Statement. Then, in the final article in this series, I’ll explain how to evaluate your year-end Balance Sheet.
Of course, these tips apply whether you’re reviewing your own company’s financial statements or you’re looking at another company’s information – such as the financial statements for a customer that has applied for credit.
Comparisons Can Be Very Helpful
A good starting point is to compare the year-end Income Statement to that of the prior year. If you’re reviewing your own company’s financials, you should also compare it to budget.
Here are some of the first things you should look at:
• Is the revenue going up or down?
• Are the gross profit margins increasing, decreasing or flat?
• Are operating expenses moving as you would expect based on the changes in revenue?
• How did actual performance compare with the budget forecast?
Understand What Happened During the Year
Reviewing an Income Statement is not just a matter of seeing if the numbers look “about right” and moving on. You also need to ask questions to understand what happened during that time period. These include:
• What’s driving the change (or lack of change) in gross profit margins?
• If operating expenses are not moving in tandem with revenue, why not? If expenses are rapidly accelerating, what’s driving it? If cost-cutting measures slashed expenses, how are these measures affecting operations?
• Were there any unusual or non-recurring expenses? How would the Income Statement look if you pulled the one-time expenses out of the picture?
Be Sure to Look Forward, Too
Next you want to ask about how the events of the past year will likely impact the company going forward. For example:
• Is it anticipated that the current levels of revenues, operating expenses and gross profits will continue in each of the next four quarters? Why or why not?
• Are the needed credit facilities in place to support operations and/or anticipated growth? As I have discussed in the past, you need to avoid growing yourself out of business."
• How are vendor relations? Are there any potential supply issues that could affect operations?
I also like to ask divisional managers what two things could be changed in company operations to increase bottom-line profit. The answers can be very revealing!