I know it’s starting to get chilly out there for a lot of us, but this week we’re sticking with the summer reboot and doing a five-minute finance lessons on the basics you need to know about your income statement, otherwise known as your profit and loss or P&L statement.
Since I work with first-time entrepreneurs who don’t typically have any background in business management, I spend a lot of time talking with my clients about financial statements and getting them up to speed on what’s what. Now, clearly, nobody is going to become an accountant overnight – nor should you try to – but every business owner should have enough knowledge to understand what an accountant is telling you about the financial state of your business and to be able to read basic financial statements yourself and get the pulse of your business’ health. So, as step one towards that goal I’m giving a series of three five-minute finance lessons to give you a brief overview of the three basic financial statements: the income statement, the statement of cash flows, and the balance sheet. This week, we’re covering the income statement.
The income statement, also known as the profit and loss or P&L statement, shows the company’s revenues and expenses over a specified period of time. It’s a bit more of a story than the static picture of the balance sheet and will be labeled accordingly: for example, Company X Income Statement for the period January 1 -December 31, 2013. The income statement is typically divided into operating and non-operating sections, though many new businesses don’t really have non-operating expenses and don’t separate the income statement in this way. The operating section should include all of the revenues and expenses that are directly related to what the business actually does. The non-operating section, by contrast, includes all of the revenues and expenses generated from any activity that is unrelated to the business’ primary operations. For example, if a business has some extra cash lying around and invests it instead of putting it back into the business, any broker fees, etc. associated with the investment and any profits made from it would fall in the non-operating section. Another example would be if a non-real estate company sold one of the buildings it owns – all of the costs and revenues associated with the sale would fall under the non-operating section. Again, these types of revenues and expenses are far less common in brand new businesses, so many business plans don’t include a non-operating section on their income statement.
Of course, the actual line items included on any income statement vary widely from company to company but it is always broken down into revenues and expenses. Expenses will be further broken down into cost of sales and selling, general, and administrative (SG&A) expenses. Cost of sales includes cost of goods sold, which are the direct costs of whatever you sell, plus any additional costs directly associated with the sale. For example, if you are a reseller of widgets and each widget costs you $10 to buy plus you need to package it for an additional $1 and you pay a sales commission of $2 for every widget sold then your cost of goods sold on one widget is $11 and your total cost of sales on one widget is $13. SG&A expenses are those that exist separate from any individual sale. You can think of these costs as the overhead costs of doing business. You need to pay your utilities bills, administrative salaries, rent, etc. whether or not you make a single sale, so these expenses cannot be included in the cost of sales but are, obviously, important to include in the income statement. They will come in under the selling, general, and administrative expenses section.
You’ll then subtract all of the expenses from all of the revenue and subtract out taxes, interest payments, depreciation, and amortization to get your net income for the period. Take a look at the example to walk through the income statement line by line and get a better understanding.
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