Understanding the Income Statement

Reading the P&L should be easy and a vital part of the healthy feedback loop

The Income Statement, the profit and loss statement P&L, provides information about an organization's sales, expenses, and net income over a particular period. This statement offers insights into a company's financial health by showing the sources of revenue and expenses incurred during a given period. This statement can be broken down into Sales, Gross Profit, Operating Expenses, Operating Income, Non-Operating Income/Expenses, and Net Profit.

First, when reading a P&L, you must know what Methodology and Accuracy to read it fluently.  I am going to focus on Accrual with high levels of Accuracy.  I am starting here because it is the most cost-effective and informative for small to mid-size organizations. Follow the link for more information on Methodology, Accuracy, and Timeliness.

We will look at Steve’s one-person company; he is a life coach.

Details are as follows:

Sales – Steve has three sales channels (three distinct ways of generating sales)

·       Speaking Engagement -  $1000 per engagement.

·       One on One Coaching -  $3500 per month.

·       Merchandising            -  prices vary by product.

Cost of Goods Sold(COGS) – The direct cost is mostly his time, which is $50 an hour. The other direct cost is the purchase price of the merchandise.

Operating Expenses - are the remainder of Steve’s salary that wasn't absorbed (absorption will be covered in a future post) to the cost of goods sold. Other operating expenses are almost everything Steve needs to run the business, such as a web page, advertising, office supplies, and other day-to-day operating expenses.

Operating Income - is the profit after covering all day-to-day in COGS and operating expenses.

Net Income - includes non-operating expenses such as taxes, interest, etc. We will not be covering those expenses here today.  This will be covered in a future post.

Let’s look at what the P&L seems like with the above:

When we read a P&L at realCFO, we start at the bottom. Steve’s Net Income* is a loss of ($16,498) year to date (YTD).

So the first question we must look at is the critical driver of the loss. We will then start to look at the % of Net Sales**. Total Compensation*** is 130.9% of the total sales YTD. We all know we can’t make money if our compensation exceeds revenue.

So what can we do to correct this issue; increase our prices, lower compensation? The market will not support increasing prices; we would lose sales to our competitors, worsening the problem. So the next thing to consider is lowering compensation; Steve knows his value and will not diminish his pay.

Let’s look at how Steve spends his time; % of Revenue Generating****. Unfortunately, Steve is only generating revenue 18.5% of the time. realCFO would start to dig in with Steve on how to get more revenue-generating hours.

Steve’s issue is easily seen when the proper P&L is laid out with good KPIs. I am using this as an example to show reading financial statements should not be difficult. realCFO is here to ensure you get all the data quickly. We do that by understanding your current Methodology, Accuracy, and Timeliness state. Then help set an easy-to-read P&L as part of a healthy feedback loop.

I look forward to helping you; let me know what you think in the comments below, or for a more personalized review, schedule an appointment with me here.