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Bookkeeping

Do You Understand Your Income Statement? If Not, Here’s What You Need to Do.

By July 9, 2021 No Comments

income statementDo you have a six-page income statement? Do you get confused by all the different names for the income statement: statement of operations, income statement, profit and loss, P&L? Does every single expense in your company get its own line item? Do you find yourself going too far down the chart of accounts rabbit hole?

If you answered yes to one or all of the above, your income statement could very well be “screwed up,” so to speak. And that’s okay—you’re not the first business owner who’s struggled with their P&L, and you certainly won’t be the last. So what should you do?

First, consider this scenario: Does it sound familiar?

A $50 charge shows up on a P&L in its own line item, but there was nothing in that column last month. Entrepreneur Andy asks questions until someone can tell him what that charge was. Andy, like many of us, is internally programmed to look for those exceptions. The problem is that information is being captured randomly (i.e. one line item might be $50,000, but the other might be the new $50 line item). If the $50,000 line item is off by $1,000, it might not raise a flag—but that $50 will send some entrepreneur down a rabbit hole.

No one wants to get lost down a rabbit hole, least of all your company, so let’s talk about a way for you to prevent spiraling down, down, down. The culprit in question is your chart of accounts, otherwise known as the listing of the line items that you want to show up on your income statement. This is also called a profit and loss statement (P&L) or a balance sheet. 

Now, we have adopted a simple rule when setting up or simplifying a chart of accounts. You only capture data in a separate line item for one of two reasons: 

  1. Compliance 
  2. To help you make better business decisions

By adhering to this simple rule, we can ensure that your income statement is meaningful, and more importantly, useful for your business. From there, we can help you streamline your income statement so it only has the items that make sense to you. 

Sound better than venturing down that rabbit hole? We thought so—let’s get started.


Compliance & Your Income Statement

When we talk about compliance, we’re referring to the fact that both individuals and businesses must comply with state, federal, and international tax regulations. Your chart of accounts plays a large role that—it must be accurate and timely.

It’s also not something you can avoid as a business owner as all U.S. companies are required to file tax returns. Luckily, federal and state forms don’t require too much detail. The following is a snapshot that contains >90% of the line item detail you will need to capture when filing taxes (meals and entertainment being the most common item you need to capture not on the front of the tax return snapshot below).

income statement

Now, if you have grants or other compliance requirements, you need to look into those reporting rules. Everyone else gets off the hook with 10-15 line items because of compliance—this is the stuff you have to capture. 

Using Your Income Statement to Make Better Business Decisions

Figuring out what else to add to your income statement is not as straightforward, which is why we’re here with another handy rule to follow. Consider combining any non-compliance line item that is less than 1.2%, which may sound like a random number, but bear with us. We are just asking, once you hit $1M in annual revenue, to consider combining any line items under $1,000 per month. Because if you are tracking phone, cable, and internet on separate lines, you need to ask yourself this: Is that helping you make a business decision?

On the other hand, if it is over 12%, you may want to consider breaking it out further. Follow these two rules for a $1M annual revenue company, and you’ll be on your way to making better business decisions:

  1. Consider combining line items below $1,000/month 
  2. Consider breaking out line items over $10,000/month 

Now ask: What should you combine?

You’ll want to combine similar items, things that don’t change month to month, or items you review regularly outside of the P&L review process. Please remember that, even if you combine items, you can still drill into the detail of all these accounting packages if you want more information in a given period.

What should you break out or leave broken out?

We suggest breaking out items like discretionary monthly dollars, travel (maybe even by department), customer acquisition costs, and marketing.

What the heck do we do with payroll?

Payroll is the biggest item on some income statements, so consider: Do you review payroll regularly in another system? Is your compensation program highly variable? Is it darn near the same number every single month? Do my department heads need to know the compensation for their department? Am I going to make a different decision about my business if I’m able to capture the information differently?

 Think about your discretionary dollars and what information you need to help you make more informed business decisions. Try out the rules of thumb: Why not cut a few pages out of that pesky P&L? Hopefully, these simple guidelines empower you and your team to eliminate those extraneous data points to get you focused on what matters: your business!

Streamlining Your Income Statement

Now that you know what to do, here’s how to do it with our “Streamlining Your Income Statement” tool that’s available to download. Get it here:


Income Statement FAQs

Still have questions about your income statement, compliance, or how a more organized P&L can help you make better business decisions? Check out these frequently asked questions to learn more. 

What is an income statement?

An income statement, or a profit and loss statement, shows a company’s revenue and expenses during a particular time period. 

But what does an income statement show?

An income statement shows how much revenue you earned during a particular time period, and also the costs and expenses associated with that same period. The idea is to show how much you profited—or how much you lost—hence, its other moniker, the P&L. 

What is a chart of accounts?

A Chart of Accounts (COA) is a list of all the accounts (which translates to line items within your accounting system) that you will be able to report on. Each transaction is assigned to an account as well as subaccounts. The purpose of the chart of accounts is to give you an overall view of your company’s spending and income in one centralized location. With this information, you’re able to report and manage critical financial information about your organization quickly. Doing so will aid you in making better decisions and maintaining accuracy.

How to set up a chart of accounts?

The COA depends on your business type and industry, so its classifications vary depending on your company type and size as well as the accounting platform you’re using. When it comes to organizing, you want to keep things clean and simple as not to increase the possibility of errors. The order of items in your chart should be based on the order that they appear on your balance sheet and income statement. Many companies will also separate this information by department (e.g., sales, marketing, technology). 

Based on the information you provide when setting up your accounting system, platforms like Xero and Quickbooks will automatically generate a standard COA for your industry. Each time a transaction is recorded in your system, it will be sorted into its assigned category and given a reference number. You can customize your COA by adding and removing accounts and subaccounts and modifying names to better suit your business. 

When making any changes to your COA, be sure to maintain the same accounts throughout the year to avoid negatively impacting your books. While adding accounts is not an issue, deleting any can cause future headaches. In addition to ensuring you have the correct categories for your business, you also want to be confident that things are in the proper order.

Income statement vs. balance sheet: What’s the difference?

We like to think of a balance sheet as a snapshot in time—a picture of where you are from a financial health perspective. Income statements, on the other hand, tend to feel more like scorecards. They cover how you did this month, or how you did this quarter, or how you did this year.

Now that you know more about your balance sheet and income statement, our hope is that you can now make actionable decisions about your business. If you still have questions, we’re here for you. Our financial experts are standing by to answer your questions and get you started on the road to success.

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