The income statement, also known as the profit and loss statement or P&L statement, is a key financial statement for e-commerce businesses, and really all business owners in general. In this article, we’ll go through what’s on the income statement as well as what numbers are specifically relevant to e-commerce.
Unlike the balance sheet which gives you a higher-level understanding of your business’s financial health, the income statement gives an understanding of how your day-to-day operations are and what your profitability is. Being able to draw strong insights will help your e-commerce business tremendously when you need to make both big and minor decisions.
What’s on the income statement (profit and loss)?
The income statement shows how your business is doing over a certain time frame, such as a month, quarter or year. You get to see your direct revenues in the first section at the top. This doesn’t include interest or other non-direct income. At the end of the section, you’ll find gross profit (Gross Profit = Revenue – Cost of Goods Sold (COGS) – Other Direct Expenses).
In the next section, you’ll find expenses and losses (other than your COGS), otherwise known as your operating expenses. This doesn’t include taxes or non-operating expenses such as interest, depreciation or unusual losses. At the end of this section, you’ll find your net operating profit (Net Operating Profit = Gross Profit – Operating Expenses).
After the operating expenses, you’ll find a section including both your interest expenses and interest income as well as any non-direct expenses and income. In the last section, you’ll see the net income (Net Income = Total Revenue – Total Expenses). Net income factors in items like depreciation, interest and taxes.
Under revenue, you’ll generally find:
- Sales revenue
- Cost of goods sold (COGS)
- Gross profit
Under operating expenses you’ll generally find:
- Marketing costs
- Website hosting
- Office supplies
Net income shows you outcome of:
- Net Income = Total Revenue – Total Expenses
Common mistakes made in the e-commerce income statement
The first mistake that many e-commerce businesses make on their income statement is incorrectly reporting revenue. Often, they’ll record revenue as whatever comes into the bank from the e-commerce platform. However, this number might actually have already subtracted credit card fees or other costs, or added other income such as shipping income.
When you record revenue in one line item based on what flows into the bank, you’re excluding a lot of vital information. Hence, you need to make sure you’re recording sales revenue separate to other types of transactions. You can use an accounting integration, such as BigCommerce + Xero, Square + MYOB or Shopify + QuickBooks, to entirely automate this data entry and breakdown process for you.
Following on from being able to record as much as possible, making sure your chart of accounts is complete and working smoothly is essential. For example, do you have separate accounts for each form of advertising such as Google Ads and Facebook Ads? Then, have you made sure your accounting software can automatically attribute these to the right account?
Last but definitely not least is making sure your COGS is accurate and up-to-date. For example, making sure you’re regularly doing stock counts and you’re including every detail about storage, warehousing, logistics, etc. This could involve linking an inventory management system to your accounting software to make everything flow more smoothly.
Why should you keep track of your income statement?
As an e-commerce business, understanding your income statement is essential to understanding the areas where you’re making a profit and where you’re making a loss. On top of that, it highlights your financial health and the state of your daily operations over a certain period of time.
Internally, it’s beneficial to compare your income statement period-to-period and analyse changes. Plus, your income statement is the foundation to any budgeting and forecasting work that you do either alone or with an accounting professional. Finally, looking at your income statement can help your business answer a range of questions operational questions such as:
- Is my advertising generating enough return?
- Do I need to switch or diversify the shipping companies I use?
- How much can I pay myself?
- What strategic hires should I make?
- Do I need to invest in more inventory?
How to analyse your e-commerce business’s income statement
You’ve set up automated data entry into your accounting software and generated an income statement, but now what? There are a few key trends to look out for that help you make sense of all the numbers. Remember, unlike a balance statement that shows your financial health at a point in time, an income statement showcases your health over a period of time.
Of course, this information will give you a great high-level understanding of your e-commerce business as an owner. However, if you want to delve deeper into different metrics and draw better insights, we recommend getting in touch with an accounting professional who specialises in e-commerce if you need more help.
Breaking down your income statement
When analysing your income statement, it’s always useful to compare from period-to-period, such as month-to-month, and to break things down as much as possible. For example, you can break down and compare your sales channels, different marketing activities and all the costs associated with COGS. The more you have, the more informed your decisions will be.
Gross profit and gross profit margin
One of the first and most important metrics to look at is your gross margin. If your gross margin is negative, this means you’re making a loss even without considering operating expenses. It may sound difficult for this to happen but factors such as storage can easily leave your COGS higher than your sales revenue.
Ideally, you want your gross profit and gross profit margin to be positive and increasing over time. Your gross profit margin ((Revenue – COGS) / Revenue) indicates your revenue after considering your production costs. The higher it is, the more profit you’re making on each sale. Your pricing strategy and decreasing COGS are key.
However, looking at gross profit alone isn’t enough to give you an understanding of overall profitability. You’ll want to compare it to your net operating profit as well as your net profit. For example, if in February, your gross profit is higher than in January, but your net operating profit is lower, you’ll need to figure out which operating expenses are generating a lower return.
Comparison with percentages
Continuing on from the above example, you know that operating expenses are worse in February but how can you figure out which one in particular? You can show your expenses as a percentage of your income and compare the changes over two periods. You might realise that in February, you increased Google Ads spend and that wasn’t worthwhile in terms of return.
Percentages can be used in all different ways. A lot of questions can’t be answered just in dollar amounts. For example, if an e-commerce business wants to know if spending $100,000 a year in storage is too much, well, the answer would lie in how much that is as a percentage of your income or COGS.
Key takeaways on income (P&L) statements for e-commerce
The income statement or P&L statement is a critical part of understanding how your e-commerce business is performing. Being able to draw insights at a glance is extremely useful in helping your business become more profitable. Whether you’re working with an accounting professional or not, having a foundational understanding as a business owner is crucial.