A Useful Income Statement
One of my biggest pet peeves as a finance consultant is when CEOs give their financials to lenders, putting themselves in the position of waiting to hear how the company is doing. In my next few articles, you will begin to fully understand your own financial statements before outsiders analyze them, beginning with the income statement (also known as the P&L; profit and loss).
Your income statement is not necessarily an accurate representation of how much cash your company has made. Some CEOs even lose interest in their income statement the more it deviates from cash generated.* For a moment, clear your mind of looking for cash performance. Instead, if you look at your income statement as a measure of how much business you’ve generated that month and how many bills you will have to pay, it suddenly becomes more useful. Further, when invoices to customers and bills to be paid are consistently booked in the month they relate to, you will start to get a very good indicator of your company’s seasonality and overall performance, regardless of when cash payments arrive.
Cost of Sales
If there is no rhyme or reason as to how your expense accounts are organized, you are likely scanning quickly to the total expense figure. However, if expenses directly related to each sale are listed in a “cost of sales” section, you’ll quickly arrive to the key indicator of gross profit (revenue minus direct costs). Your gross profit tells you approximately what your sales cost even before you pay the bills to run the office. For example, if your gross profit is showing a negative number, raise the red flag. There’s no need to jump straight to cutting back on utilities or minimizing lunches because negative gross profit tells you that bigger issues are present in items like pricing and materials.
General and Administrative Expenses
After your direct cost of sales, a general and administrative expenses section should follow. This “everything else” category should also be organized to be useful. If you add numbers to the accounts in your system, it will allow you to list things in order of importance or similarity, rather than alphabetical order. For instance, if payroll, payroll taxes and health insurance are listed together, you will have a pretty good idea of what your office employees cost you. My advice on organizing your general and administrative expense accounts on your income statement is to make it relevant to you. When you begin to compare months, you’ll quickly see expenses that deviate from the norm.
Other Income and Expenses
The other income and expenses category is reserved for items that are not part of the core business or that are non-routine. For instance, gain/loss on sale of assets, unusual bad debt, extraordinary expenses, income taxes, interest income (non-routine). Don’t be afraid to use that extraordinary expense category for happenings like the random lawsuit, disaster recovery, and fraud. It’s a great way to identify things that are non-recurring and therefore shouldn’t be measured as part of the core performance.
Net income is commonly known as your bottom line. Net income to finance savvy folks is by definition “income AFTER all expenses, taxes, depreciation and amortization.” Net income is the last line of the income statement and the final result of the income statement performance.
Net income isn’t a cash figure, as you know, but if you are the CEO, I suggest challenging CFOs like me or your accounting department to show you the difference between net income and cash and walk you through the explanation. Most likely, you’ll get some supplementary information like a statement of accounts receivable as well as a statement of payables along with their explanation.
In next month’s article, I’ll show you how to use balance sheet information along with your income statement performance to gain a clearer picture of your company’s finances.
* Cash versus net income differences can be due to the following: In accordance with generally accepted accounting principles (GAAP), invoices to customers generate a sale (revenue) on the income statement as soon as the invoice is entered. Similarly, bills to be paid (payables) are booked as an expense as soon as the bill is entered into the accounting system, not when it is paid. Cash investments into assets and inventory and loan funds received are not fully reflected on the income statement. Other non-cash items can include: depreciation and tax recognition.
Kira Spivak, founder of CFO Services, has been easing the minds of CEOs and their investors for 19 years. After gaining experience as the Manager of Equipment and Assets for Brannan Sand & Gravel Company and Director of Finance for Renewable Choice Energy, Kira founded CFO Services, LLC in 2007. Ms. Spivak is currently the CFO for Rocky Mountain Excavating and Concrete, Inc., where she has enjoyed the growth phases of transitioning from a small to mid-sized business through challenging economic times. In addition, CFO Services continues to provide financial solutions to corporate clients and investors in a variety of industries.