Merely glancing at the bottom line and moving on is tempting when you receive your financial statements. It may feel as though you have other, more important things to do such as serve customers and manage employees. However, it’s important to remember that your income statement is more than just a report card. It can be utilized to move your business forward by helping you spot growth opportunities, tighten your execution, and make smarter decisions.

Measure What Matters

The income statement is a good starting point for analyzing your financials and identifying inefficiencies and anomalies. The following ratios are commonly used to gauge profitability:

Gross profit margin. This is gross profit (revenue minus cost of goods sold) divided by revenue. It’s a good ratio to compare with industry statistics because it’s typically calculated on a consistent basis, though the definition of cost of goods sold can vary between companies.

Net profit margin. This is calculated by dividing net income by revenue. If the margin is rising, the company is generally doing something right. Often, this ratio is computed on a pretax basis to accommodate differing tax rates.

Return on assets. This is net income divided by the company’s total assets. The return shows how efficiently management is using its assets.

Return on equity. This is calculated by dividing net income by shareholders’ equity. The resulting figure shows how well the shareholders’ investment is performing compared to competing investments. However, private companies should use this ratio with caution because their equity levels can fluctuate due to owner withdrawals or tax strategies.

You can use these profitability ratios to compare your company’s performance over time and against industry norms.

Dig Deeper Into The Details

If your company’s profitability ratios have deteriorated compared to last year or industry norms, it’s important to find the cause. If the whole industry is suffering, the decline is likely part of a macroeconomic trend. If the industry is healthy but your company’s margins are falling, it’s time to identify internal factors and take corrective measures.

Depending on the source of the problem, you might need to cut costs, reevaluate staffing levels, automate certain business functions, eliminate unprofitable segments or product lines, raise prices, or possibly conduct a forensic accounting investigation. For instance, a hypothetical manufacturer might discover that its gross margin fell due to rising labor costs from excessive overtime or because supplier prices rose faster than the company adjusted its pricing.

Build A Winning Game Plan

In today’s volatile economy, it’s easy to blame shrinking profit margins on external pressures. But assumptions can be costly. Your income statement provides insight into your team’s performance, from your operational efficiency to pricing and spending. A careful review of your income statement — including revenue trends, cost drivers, and operating expenses — often uncovers actionable opportunities for improvement. We can help you develop strategies to boost profitability and keep your business competing at the highest level.