Understanding the Income Statement

Welcome to Boosting Your Financial IQ, a podcast for business leaders, entrepreneurs, and individuals, looking to transform their organizations and lives through greater financial literacy. I'm your host, Steve Coughran. I'm a tech entrepreneur, a past large company CFO, an avid marathon runner, and a huge lover of finance and strategy.

I'm here to teach you the fundamentals of accounting and finance. So, you can speak the language of money and act intentionally to drive greater financial value. Are you ready? Let's do this. Hey guys, welcome to a new episode of boosting your financial IQ. I'm sitting here in my office in Denver, and I'm thinking about how do I want to deliver these podcasts episodes because, look, let's face it. Boosting Your Financial IQ, listening to a podcast about financial literacy is probably not the most exciting thing that you could be doing. In fact, when I talked to my employees here at Coltivar, a lot of times they'll tell me what type of, podcasts they're listening to.

And usually they're like murder, mystery podcasts, or sports podcasts... and then here I am creating this podcast about financial literacy, but I do think this topic is very important. So just because it's finance and about numbers, it doesn't mean that you should run away. So, I'm going to make these episodes as fun as possible. 

But here's what I need, I need your help. As you're listening to these podcasts, it would mean the world to me. If number one, if you could like my show and number two, if you could provide comments on what types of things you liked, things that you didn't like or things that you want me to discuss, moving into the future.

Then my team and I can plan out episodes that are relevant to you guys that’s ultimately the goal here. All right. So I'm going to try it. We'll make this fun. We're going to be talking about the income statement and understanding the income statement. And I'm thinking, how do I consume podcasts?

I'm either listening to them in my car as I drive, or I listen to podcasts when I'm working out or when I'm running. So I'm thinking here, okay. If I was running on a trail, would I want to listen to a boring podcast about the income statement? And the answer is no, but here's the difference. I am going to try to make this as fun as possible.

I'm even going to sing you a little song in this episode just to bring some entertainment into your life. All right. So let's get into understanding the income statement because everybody in the company impacts profit and that's, what's on the income statement. Ultimately, whether you're a business owner, a business leader, A frontline employee, wherever you sit on the org chart, the income statement is very important to understand.

So what is the income statement? So think of it like this, you are playing the game of business. Okay. Just like you're playing football or basketball or soccer or whatever game you like to play. You're playing something type of game. And this is the game of business. Don't you want to keep track of how well you're doing?

So imagine playing a football game and there's no scoreboard. Or imagine you're playing Settlers of Catan. I played that before with friends, that's pretty fun game and there was no way to keep track of who's right. Winning. Now that would be ridiculous. Imagine you're playing a game and you just said, well, I'm not going to pay attention to the scoreboard.

It's too confusing. That would be similar to running a business or working in a business and not being curious about the financial performance of that business. That's why the income statement is so critical to understand. So the income statement is the scorecard. It tells you how well the company is generating revenue, earning gross margin, managing its overhead, and a profit.

So that's what the income statement is all about. The income statement measures. Ultimately, what we're looking at is it measure is revenue, your cost of goods, sold and revenue minus cost of goods sold equals your gross margin and then gross margin minus your overhead or your SGNA costs. You're selling general and administrative costs.

Which is your overhead, your fixed expenses. You take gross margin minus your SGNA, and you end up with profit. All right. So now you get the pleasure of hearing this song that was solely written by Steve coffer and by me, pretty proud of it, but I'm not so proud of my singing because my voice is absolutely horrible, but because you are tuning in, I want to provide you some entertainment, therefore.

I will be vulnerable right now. And I will sing you a song, even though you will probably think it's absolutely ridiculous. And some of you may never return to the podcast again, but you know what, that's the risk I'm willing to take. So here we go. 

The income statement mint is a flow through, always starts with revenue. Cost of goods sold and SGNA and you end up with profit at the end of the day.

Right, So there you have it. There's the income statement. So let's break that down. The income statement is a flow through. It's a financial statement that flows down to profit and it flows through to the balance sheet. And I'm going to talk about the balance sheet in my next episode, Kevin.

So the income statements, a flow through the profit flows through to the balance sheet where it sits in this equity bucket. More to come on that. So it's a flow through, it starts with revenue, cost of goods sold and then SGNA, and you take those out and you end up with profit at the end of the day.

Now I've been singing this song for years and people think it's absolutely crazy, but here's the thing as nerdy as it is. I hope that it will help you to remember what is on the income statement. So one more time, the income statement is a flow through always starts with revenue, cost of goods sold and SGNA, and you end up with profit at the end the day.

Now, if I was to give you a quiz, for example, and I said, where are assets or where would he find liabilities on which financial statement would you find them? If you answered the income statement? You just completely ignored my song. You completely missed the whole point. I'd never said the income statement is a flow through always starts with assets in line abilities.

Okay. Those are on the balance. So remember the income statement is a flow through revenue, cost of goods, sold SGNA and profit at the end of the day. And there's two types of profit gross profit, which is revenue minus cost of goods sold and operating profit, which is your gross margin minus out your overhead.

So don't get those confused and don't get the question wrong on the test. If I ask you what financial statement will you find assets, that's why the song is there. And that is why I made a complete fool of myself singing that for you. So you would remember that and it burned into your mind.

How do you format an income statement? First of all, you may use QuickBooks. You may use Sage, you may use viewpoint, you may use one of them, any software products out there that helps you to track your accounting. Okay. Whatever you use. Most of the reports, when you go to pull an income statement. Or it's also known as a profit and loss or statement of operations, whatever it's called K there's, there's multiple names for it, but they all mean the same thing, income statement, profit and loss statement of operations.

Ultimately, it'll pull it and it'll, it'll probably just have one column of just that month, that period of time with the revenue cost of goods sold as SGNA and profit are for that specific time. Now what's helpful is to put the income statement. In a month over month format. So that's the first thing you want to do is when you pull your report, you want to pull it over a period of time, and you want to make sure that the months are represented in each of the columns.

So let's just say, I want to look back on the last six months and we're sitting here in October. I would want to look from March. Okay. That'd be my first column. April will be my second may, June, July, August, September. Those would be my six columns there. And I look at the financials month over month. The reason why I want to look at the income statement month over month is because I want, want to look for trends.

I want to see is revenue going up or is it going down? What's my overhead doing? Is it staying steady? Is it declining? Is it increasing? What about my profit? So when I look month over month, it helps me to see the trend. The next thing I want to do is I want to create a column that's trailing 12 months. I want to show in the far column, the last 12 months.

So if I'm sitting here in October and let's just say, it's the beginning of October and September is closed. I want to look at the last 12 months from October of last year through September of this year. Those are the last 12 months now easily. I'm not going to have the calendar year, January through December, cause I'm sitting here in October.

So instead I want to look at a year. Based on where I am today. So pulling the last 12 months, the trailing 12 months and putting that in a column is going to be helpful as well. Also showing each other the line items as a percentage of revenue is going to be really effective. So what you do is go back to your March column you're going to take your revenue. And right next to it, create a column that says percentage of revenue and take revenue divided by revenue. It'll give you a hundred percent. And then go down to your cost of goods, sold each year line items and take each of those divided by revenue. And then you'll start getting a percentage.

So you take your direct labor divided by revenue. Your material costs divided by revenue, your rent divided by revenue. Then you keep going down the line. So everything is divided by revenue. What this does is it helps you to understand as a percentage of revenue where everything is shaking out. So, what I like to do is I'll look at things like gross profit, and I'll look at it as a percentage of revenue.

So let's say it's 38% gross. Profit is 38% of my revenue. What that means is that for every dollar I bring into the company, 38 cents or 38% of every dollar, 38 cents is captured in gross profit. So then you can start seeing on a dollar basis, you can see where costs are going, and that's really important because then you look at it and you're like, dang, rent. Is 8 cents of every dollar I bring in? Or labor is 55 cents of every dollar I bring in. And you can start to normalize these numbers and you can really start to understand your cost structure and your profit margins. So putting it as a percentage of revenue is really important. All right. So that's just some basic formatting.

There's a lot of other things you can do with formatting, but those are some of the basic things. All right. So now let's go through the income statement line by line. And let me just tell you a few things to look at. 

The first thing you want to look at is revenue. Okay. That's the top line. Most people call it the top line. So they're like, Hey, are you managing your top line? Are you proud of your top line? They're talking about your revenue. Revenue sales, same thing. So this is the amount of money that your company as earned. Now, if you just bill a customer, you create a bill in your accounting system and you send it to a customer.

Let's just say, it's a, before you start work, you send them a $20,000 invoice. Your first installment, if that's just recorded as revenue, but you haven't earned it, you got to fix that guy. I'll do it. I'll do an episode later on about how to defer revenue, but what you want to be looking at is revenue that you've actually earned.

Okay. Work that's been performed. And that's actually earned. Otherwise, you're just looking at billings and that doesn't tell you anything. So make sure that that's correct. You look at the revenue number and you ask yourself, does this match. My sales expectations. What were your sales goals for the month?

So if you had a $50,000 sales goal, you look at revenue and you only earn $40,000. Obviously that's a problem. And you want to look at your sales tactics. Okay. Do you have the right sales approach? How's your BD, how's your marketing inbound, outbound. And you can start to figure out whether you have an issue with revenue generation.

Next. You want to go down to cost of goods. Sold. Look at all those things. Cost of goods sold. These are costs that are associated with producing yourselves. So they're called cost of sales, cost of revenue, cost of goods sold all the same thing. These are direct costs and indirect costs that are related to producing the revenue cost of goods.

Sold may include things like material costs, subcontractors, direct labor, equipment maintenance, and other costs related to producing your revenue. Now keep in mind. I said equipment maintenance. I didn't say the equipment cost itself. That's really, really critical to differentiate between because the acquisition or the purchasing of it, what van shows up on the balance sheet?

Not on the income statement. Okay. That's another lesson down the line. Don't worry about that. You're going to be a financial guru as you continue to listen to these podcasts. And as you check out the YouTubes that I put out on a weekly basis. All right. So you look at cost of goods sold. You, you want to identify, are there any trends, like are our labor costs as a percentage of revenue, are they going up? Are they going down what's happening there because labor is going to be probably one of your biggest costs on your income statement. So you really want to pay attention to that. Okay. After that, look at your gross margin, your gross profit, same thing, gross margin, gross profit.

And you want to try to benchmark that compared to your industry to see how well you're doing. You want to see how effective is your company at producing gross profit. So can your company produce products and services at a profit? So if you take revenue minus your cost of goods sold, and you look at your gross profit, and if you're not making money, they're at your gross profit line item, you got a problem with your operating model.

It means you cannot produce products and services and sell them at a price or volume. Sufficient enough to earn a profit. So you have to fix that. All right. So you look there at your gross profit, then you go down to your overhead costs and you want to look at all those items, see how they're trending.

Now, this is where you don't want to get lost in the weeds because some people look at their income statement and they're like, Oh my gosh. Look at our office supplies. They've increased by 60%. I mean, it's like, well, yeah, they've increased 60%, but the number is so small, 60% means nothing. So maybe last month you spent a hundred dollars and then the next month you spent like $160.

So don't get too caught up with the small accounts. Look at the things that really will make an impact in your company. And the big things are typically going to revolve around labor, productivity, efficiency, pricing, things like that. Not like your office supplies. I hope, I hope you're not going crazy on office supplies.

All right. So when you look at your overhead, look for trends, see if things are out of control, but here's another thing you can do. I like to look at overhead divided by something. So if you take overhead and you divide it by like head count, like the number of employees that you have on your team, or you divide it by like the number of trucks you have, or the number of square feet that you have in your retail shop or a restaurant, or if I had to buy something.

So then it puts things into context. So what I used to do when I was CFO is I'd look at overhead per head count. So every time we hired people, I'd watch the trend to see if my overhead per person was going up or down. And then that's how I could quickly gauge whether or not we were lopsided with our staff.

So looking at overhead on that type of basis can be helpful. And then finally look at operating profit operating profit. We'll tell you whether or not your business can generate a profit after. Selling products and services and taking it's gross, profit subtracting it's fixed costs, it's overhead. And that's going to be really important.

Now below operating profit, you may have some like other income, other expense line items that are not associated with normal operations. So for example, like your interest expense should go down and other income because you're not in the business of earning interest. So that should not be a part of operating income.

So that's going to be important to put like non-operating items in this other category. And then you ended up with net income. All right. So that's just the high level. I just want to start really high level in these first episodes. And then what I'm going to do is after I get through understanding the income statement, understanding the balance sheet, understanding the statement of cash flows.

My favorite. I love that statement. After I go through these three. I'm going to start doing episodes that are even more targeted. So it's kind of like the app, Duolingo, that Duolingo helps you learn like a language. So I'm using that right now to sharpen my Spanish skills. So as I'm going through Duolingo, I take little lessons along the way, and that's what I want to do with Boosting Your Financial IQ.

I want to break it down into subjects. Digestible subjects. So slowly your financial literacy grows every single time. So today, if you could just take away one or two things from this episode, what would they be? Go ahead and enter those in the comments box. In this episode, I'd love to hear what you're thinking and if you haven't already, I'd really appreciate it if you liked this episode on whatever platform you are in, because if you like it, or if you provide comments or if you provide a review, that would mean the world to me. Did you know that 3.5 billion adults globally, lack of basic understanding of financials, and that's what I want to get out there to the world.

And I appreciate your support. And for you joining me on this episode, I hope to make more of these fun. So give me feedback, please, so I can continue to deliver value to you. And in the meantime, remember the song, the income statement is a flow through always starts with revenue, cost of goods sold and SGNA and you end up with profit at the end of the day.

If that's all you remember today, success, and I wish you all the best as you continue to increase your financial IQ. Thanks for joining me. And until next time, take care.