Part 5: Understanding Business Finances
The Income Statement and Profitability
Profitability is what keeps your business moving forward.
While the balance sheet provides a snapshot of what a business owns and owes at a specific moment, entrepreneurs also need to understand something equally important: is the business actually making money? The financial statement that answers that question is called the income statement. It summarizes a business’s financial performance over a period — a month, quarter, or year — showing how much revenue was generated, what expenses were required, and whether the business earned a profit or experienced a loss.
Learning Objectives
By the end of this chapter, you will be able to:
- Explain the purpose of an income statement and what it reveals about business performance
- Distinguish between revenue, cost of goods sold, gross profit, operating expenses, and net income
- Explain the difference between markup and profit margin and why confusing them leads to underpricing
- Recognize that profit and cash are not the same thing
Revenue
Revenue represents the money the business earns from selling its products or services. For trades businesses this might come from service calls, project work, installation services, maintenance contracts, or hourly labour. Revenue reflects total income generated before any expenses are considered.
Cost of Goods Sold and Gross Profit
Some expenses are directly tied to the work being performed. A contractor installing a lighting system purchases wiring, fixtures, switches, and connectors — those materials are the direct cost of completing that job. This category is called cost of goods sold (COGS) and is listed separately because it moves directly with the work being done.
Once COGS is subtracted from revenue the remaining amount is gross profit. That gross profit must then cover all remaining operating expenses.
Gross Profit = Revenue − Cost of Goods Sold
Markup vs. Profit Margin
When pricing services, two terms come up repeatedly: markup and profit margin. They are sometimes used interchangeably, but they describe two different things. Confusing them is one of the most common ways trades business owners accidentally underprice their work.
Markup refers to how much the price of a product or service is increased above its cost. If materials cost $100 and a 30% markup is applied, the selling price becomes $130. Markup is calculated based on cost.
Profit margin describes the percentage of the final selling price that remains as profit. Using the same example: selling price is $130, cost is $100, profit is $30. Profit margin = $30 ÷ $130 = approximately 23%. Even though a 30% markup was applied, the actual profit margin is only 23%.
This difference matters because the gap between markup and margin becomes more significant as percentages increase. A business applying a 20% markup achieves only about a 17% margin. Apply a 50% markup and you get a 33% margin — not 50%. Treating them as equivalent means earning less than intended on every job.
Operating Expenses and Net Income
Operating expenses are the costs of running the business that are not directly tied to a specific job — rent or shop space, advertising, wages for office staff, accounting services, software subscriptions, phone and internet. These costs occur whether or not a specific project is being completed and are sometimes called overhead.
After subtracting operating expenses from gross profit the final result is net income — the overall profit or loss for the period.
Net Income = Revenue − Total Expenses
A simple example: a plumbing business earns $20,000 in revenue. Materials cost $8,000 (COGS), leaving a gross profit of $12,000. Operating expenses are $6,000. Net income for the month: $6,000.
Profit Does Not Always Mean Cash
Profit and cash are not the same thing. A business may appear profitable on an income statement but still struggle financially if customers delay payment or if expenses must be paid immediately. A contractor who completes $20,000 of work in a month but does not collect payment for 60 days is profitable on paper but may not have the cash to pay their bills in the meantime. This is why cash flow deserves its own attention — which is exactly what the next chapter covers.
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Key Takeaways
- The income statement measures business profitability over a period of time by reporting revenue, expenses, and net income.
- Gross profit is revenue minus cost of goods sold; net income is what remains after all operating expenses are subtracted.
- Markup is calculated on cost; profit margin is calculated on selling price — treating them as the same leads to systematic underpricing.
- A profitable income statement does not guarantee cash in the bank — the timing of payments creates a separate challenge addressed by cash flow management.
Reflect
Think about the type of work you plan to do. What would be included in your cost of goods sold versus your operating expenses? If you applied a 30% markup to materials on every job but thought of it as a 30% margin, how would that affect your actual profitability over the course of a year? What would you do differently?
