The multi-step income statement is the textbook version of what most people use to record their income. Here, Julia describes how to use three important numbers for identifying your business’s financial health.
The multi-step income statement is actually the more common of the two than the single-step, so it is a good idea to learn how to use it and how it looks. The first line, the top line, is the revenue. That is what the company earned through the course of business. For example with the Granite Mountain Enterprises, let’s say they are selling granite, and this is $120,000 of revenue that they earned through the course of selling granite, maybe part of the revenue was from installation and delivery services.
Not in the revenue are things like interest earned on a bank account. It’s technically income, but it is not revenue. It is not what they do through the course of their business.
Next we have cost of goods sold, or “COGS” – you might often see it as “COGS”. This category is what it cost to purchase the granite or manufacture the granite. It’s the actual cost of the granite that is then sold. If you have a shoe store, it is the actual cost of the shoes that you purchase to sell. If you have an electronics store, it’s the actual cost of the electronics that you buy to then sell. You subtract the COGS from the revenue and that gives you your gross profit. This is a good number to look at because this is what you have to run the rest of your business.
After you pay for the goods that you are selling what do you have for payroll, for operating expenses, for occupancy, for rent? In this case, they have $75,000 to cover all their other expenses. So what are they? In this case they have selling expenses of $8,000, administrative expenses of $10,000, and research and development expenses of $4,000. The next line is then the operating income, and that is subtracting all of these expenses from the gross profit, and that is going to give us $53,000 in operating income.
The gross profit number is a really important number for several reasons. First of all, it is going to tell you what you have for your operating and expenses; for paying your sales staff, paying your administrative staff, paying for rent, office supplies. What do you have left over to pay all of your operating expenses? But you also want to take a look at your gross profit to evaluate how much you are paying for your goods that you are reselling and how much you are charging. If your gross profit is too low, it could be one of two things. One, you are paying too much for your inventory, or two, you are not charging enough. So you want to take a look at your gross profit to see how you feel about your pricing structure and what you are paying for your goods.
Then you get to your operating income, which tells you how you are doing through the course of running your business. It’s an important number, and really a stopping point before you get to your net income, because everything that comes below operating income isn’t really what you are doing through the course of your business. It is extraneous stuff. If you are selling equipment; maybe you lost money or gained money. Did you pay off interest expense or did you earn interest on your bank account. So the operating income really tells you what you are doing with your business and if you are running a profitable business. And that can be masked if you only look at the net income, in this case it is $49,500, which is a little bit lower because you had the loss on the sale of equipment and you paid interest expense.
So you have three important numbers to look at with the multi-step income statement. First of all you want to look at the gross profit to make sure that you are charging enough for your goods and you are not paying too much for your inventory. How you are running your business operationally, if you are making enough money through the operations of your business. And finally, of course, you want to have a positive net income, which can be impacted by other income and other expenses.