Getting to the Bottom Line:
How to Read and Use Your Income Statement
by Corporate Relations and Business Strategy Staff
This article is the second in a series designed to help you make sense of your practice's financial statements. In the first article, we examined the balance sheet as a snapshot of your assets, liabilities and equity at a particular point in time. This article takes a look at the income statement, a financial report that details the money your practice earns, the expenses it incurs and the resulting profit or loss over a period of time.
Introduction to Income Statements
Your income statement (sometimes called a statement of revenue and expense) shows the revenue your practice earned and the costs associated with running your business. Although an income statement can be prepared for any interval, it is usually prepared annually. For example, an income statement that includes financial data for 2003 and 2004 would be titled, "Income Statement, Years Ended December 31, 2003 and 2004."
If an income statement reports data for shorter intervals, for example monthly or quarterly, it may include the total anticipated amounts for the year in one column, followed by revenue and expenses for the current period, year-to-date amounts, and current period and year-to-date amounts as a percentage of the projected annual total.
A sample income statement for the fictitious Springfield Psychological Services is presented below.
The layout of an income statement is simple to follow. Sales start at the top, expenses and other costs are subtracted as you go down the column and "the bottom line" tells you how much money your practice earned or lost at the end of the reporting period.
Sales (sometimes called client service revenue) reflects revenue from the provision of services or sale of products. Sales may be combined and simply listed on one line, or separated into subcategories to provide additional detail about revenue-generating products or services.
Sales are totaled and listed as "total sales" or "total revenue."
The next section lists expenses related to running your practice. These may include fees for consultants such as accountants and attorneys, wages for administrative staff, costs associated with advertising and marketing activities, depreciation of office equipment and furniture, rent, utilities, professional memberships, liability insurance, provisions for bad debt and other costs of doing business.
Expenses are totaled and listed as "total expenses."
Following the expense section of the income statement, total expenses are subtracted from total sales to calculate "operating income," your profit from operations before interest and taxes.
Nonoperating Gains and Losses
Revenue that is not related to the core operations of your practice is accounted for in this section. This may include interest and other earning from investments, donations and gains or losses from the sale of assets.
Interest paid on outstanding loans is also listed in this section. Some income statements detail both interest earned and interest paid, while others show only the total.
The amount of income tax you have paid, or expect to pay, for you practice is listed for the reporting period covered by the income statement.
Finally, at the bottom of the page, appears the number everyone is interested in: net income. Also called net profit or net earnings, net income reflects how much your practice actually earned or lost during the reporting period. This is essentially amount of money remaining after all expenses are subtracted from total revenue.
Like the balance sheet, your income statement provides some of the data you will need to calculate the basic financial ratios that can help you track the performance of your practice, identify trends, and implement strategies to shore up your finances. With income statement data, you can evaluate factors such as your profitability and ability to manage your expenses.
Combined with data from your practice operations and other financial statements, your income statement allows for an even more in-depth understanding of your practice finances:
How well are you using your assets to generate revenue?
How effective are you at collecting payments owed to you by third-party payers?
Which of the services you provide are making or losing money?
What referral sources and payers account for the biggest sources of your revenue?
Although the income statement represents a particular period of time, most income statements will also include data from the previous year (or even multiple years) to facilitate comparison and see how your practice is doing over time.
Compare the current reporting period with previous ones using a percent change analysis. Are your revenues growing? Have your expenses increased exponentially and, if so, which expenses are out of control? Is your practice becoming more or less profitable? Are your biggest revenue sources changing? Does a pattern of tax increases warrant seeking consultation with a tax advisor? Are you spending more time on less profitable activities? Calculating financial ratios and trends can help you identify potential financial problems that may not be obvious to the naked eye.
Developing a better understanding of your practice finances can give you the tools to set your own course to success and make well-informed decisions that benefit both you and the clients you serve. Additional resources for managing your practice finances will appear in future issues of the PracticeUpdate E-Newsletter.