How to Read an Income Statement

Last month, I discussed the importance of learning to read and understand financial statements. It is the only way in which you can truly evaluate your practice's financial health.

I named the three barometers of financial strength: liquidity, solvency, and profitability. The first two are measured with the balance sheet, which I covered last month. Measuring profitability requires a separate tool: the income statement.

An income statement summarizes revenue and expenses for a specific time period, usually a year, although reports should be generated more frequently for large or complicated practices. Here are the essential components:

▸ Total sales revenue (TSR). Nicknamed the "top line," TSR represents the practice's gross income for the period. In large offices with multiple "providers" and/or multiple specialized services, TSR will be broken down to identify and track all major revenue producers.

▸ Operating costs. In other words, overhead. For many practices, there is only one category of operating costs, usually called general and administrative expenses (G&A). However, if you offer ancillary services, such as a spa, or sell a lot of products, your income statement should separate the costs of producing these products or services into a separate category called sales costs. Cosmetically oriented practices with large marketing expenses should have a third category to track them.

Many physicians instinctively strive to slash operating costs, but they often fail to distinguish between G&A expenses—which should be kept as low as possible—and sales and marketing costs. The latter often must be maintained or even increased. A practice spending 30% on overhead, for example, is not necessarily doing as well as one spending 60%: Would you rather have 70% of $250,000 or 40% of $1 million?

▸ Gross profit (or loss). In practices with significant sales costs, this is the difference between sales revenue and sales/marketing costs. A positive difference is profit; a negative difference is a loss and is shown in brackets. If you offer ancillary products or services, this category determines if they, by themselves, are making money.

▸ Operating income. What's left when you subtract all the operating expenses from gross profit.

▸ Income before taxes. After subtracting any interest paid on outstanding debt from total operating income, you are left with the amount on which the practice may be liable for taxes.

▸ Taxes. All paid or anticipated taxes during the period, to all jurisdictions.

▸ Net income from continuing operations. After subtracting taxes from its income, this is what is left.

▸ Nonrecurring events. This is the cost of any one-time expenses, such as restructuring the practice or an unreimbursed casualty loss. These are shown on a separate line so as to not confuse the "continuing operations" figure.

▸ Net income. What the practice has left after subtracting all its expenses from its total revenue. If the difference is positive, it is profit. A negative difference is a loss and is shown in brackets. This is a different benchmark for a professional corporation than for most businesses, since professional corporations strive to minimize net income, and thus corporate taxes.

▸ Net income available to shareholders. This is the bottom line, the money left at the end of the period. It is held for future needs, invested as the board directs, or returned to investors in the future.

It takes awhile to become adept at analyzing financial reports, so ask your accountant to walk you through your practice's balance sheet and income statement and point out the important indicators.

Last month, I discussed the importance of learning to read and understand financial statements. It is the only way in which you can truly evaluate your practice's financial health.

I named the three barometers of financial strength: liquidity, solvency, and profitability. The first two are measured with the balance sheet, which I covered last month. Measuring profitability requires a separate tool: the income statement.

An income statement summarizes revenue and expenses for a specific time period, usually a year, although reports should be generated more frequently for large or complicated practices. Here are the essential components:

▸ Total sales revenue (TSR). Nicknamed the "top line," TSR represents the practice's gross income for the period. In large offices with multiple "providers" and/or multiple specialized services, TSR will be broken down to identify and track all major revenue producers.

▸ Operating costs. In other words, overhead. For many practices, there is only one category of operating costs, usually called general and administrative expenses (G&A). However, if you offer ancillary services, such as a spa, or sell a lot of products, your income statement should separate the costs of producing these products or services into a separate category called sales costs. Cosmetically oriented practices with large marketing expenses should have a third category to track them.

Many physicians instinctively strive to slash operating costs, but they often fail to distinguish between G&A expenses—which should be kept as low as possible—and sales and marketing costs. The latter often must be maintained or even increased. A practice spending 30% on overhead, for example, is not necessarily doing as well as one spending 60%: Would you rather have 70% of $250,000 or 40% of $1 million?

▸ Gross profit (or loss). In practices with significant sales costs, this is the difference between sales revenue and sales/marketing costs. A positive difference is profit; a negative difference is a loss and is shown in brackets. If you offer ancillary products or services, this category determines if they, by themselves, are making money.

▸ Operating income. What's left when you subtract all the operating expenses from gross profit.

▸ Income before taxes. After subtracting any interest paid on outstanding debt from total operating income, you are left with the amount on which the practice may be liable for taxes.

▸ Taxes. All paid or anticipated taxes during the period, to all jurisdictions.

▸ Net income from continuing operations. After subtracting taxes from its income, this is what is left.

▸ Nonrecurring events. This is the cost of any one-time expenses, such as restructuring the practice or an unreimbursed casualty loss. These are shown on a separate line so as to not confuse the "continuing operations" figure.

▸ Net income. What the practice has left after subtracting all its expenses from its total revenue. If the difference is positive, it is profit. A negative difference is a loss and is shown in brackets. This is a different benchmark for a professional corporation than for most businesses, since professional corporations strive to minimize net income, and thus corporate taxes.

▸ Net income available to shareholders. This is the bottom line, the money left at the end of the period. It is held for future needs, invested as the board directs, or returned to investors in the future.

It takes awhile to become adept at analyzing financial reports, so ask your accountant to walk you through your practice's balance sheet and income statement and point out the important indicators.

Last month, I discussed the importance of learning to read and understand financial statements. It is the only way in which you can truly evaluate your practice's financial health.

I named the three barometers of financial strength: liquidity, solvency, and profitability. The first two are measured with the balance sheet, which I covered last month. Measuring profitability requires a separate tool: the income statement.

An income statement summarizes revenue and expenses for a specific time period, usually a year, although reports should be generated more frequently for large or complicated practices. Here are the essential components:

▸ Total sales revenue (TSR). Nicknamed the "top line," TSR represents the practice's gross income for the period. In large offices with multiple "providers" and/or multiple specialized services, TSR will be broken down to identify and track all major revenue producers.

▸ Operating costs. In other words, overhead. For many practices, there is only one category of operating costs, usually called general and administrative expenses (G&A). However, if you offer ancillary services, such as a spa, or sell a lot of products, your income statement should separate the costs of producing these products or services into a separate category called sales costs. Cosmetically oriented practices with large marketing expenses should have a third category to track them.

Many physicians instinctively strive to slash operating costs, but they often fail to distinguish between G&A expenses—which should be kept as low as possible—and sales and marketing costs. The latter often must be maintained or even increased. A practice spending 30% on overhead, for example, is not necessarily doing as well as one spending 60%: Would you rather have 70% of $250,000 or 40% of $1 million?

▸ Gross profit (or loss). In practices with significant sales costs, this is the difference between sales revenue and sales/marketing costs. A positive difference is profit; a negative difference is a loss and is shown in brackets. If you offer ancillary products or services, this category determines if they, by themselves, are making money.

▸ Operating income. What's left when you subtract all the operating expenses from gross profit.

▸ Income before taxes. After subtracting any interest paid on outstanding debt from total operating income, you are left with the amount on which the practice may be liable for taxes.

▸ Taxes. All paid or anticipated taxes during the period, to all jurisdictions.

▸ Net income from continuing operations. After subtracting taxes from its income, this is what is left.

▸ Nonrecurring events. This is the cost of any one-time expenses, such as restructuring the practice or an unreimbursed casualty loss. These are shown on a separate line so as to not confuse the "continuing operations" figure.

▸ Net income. What the practice has left after subtracting all its expenses from its total revenue. If the difference is positive, it is profit. A negative difference is a loss and is shown in brackets. This is a different benchmark for a professional corporation than for most businesses, since professional corporations strive to minimize net income, and thus corporate taxes.

▸ Net income available to shareholders. This is the bottom line, the money left at the end of the period. It is held for future needs, invested as the board directs, or returned to investors in the future.

It takes awhile to become adept at analyzing financial reports, so ask your accountant to walk you through your practice's balance sheet and income statement and point out the important indicators.