What to Include When Building Your Income Statement

December 14, 2008 · Posted in Business Operations, Online Marketing 

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Often when a entrepreneur starts a business, he or she creates an income statement for the plan that is often built on unrealistic expectations and/or missing key elements. Understanding what goes into an income statement will help you create a realistic plan.

An income statement is separated into several parts. The first section is the revenue section, which can be one line or several lines if you want to break out your revenue by product or service. In general, your revenue can grow as quickly as you would like, but you must understand the drivers behind your growth.

For instance, if you have developed a new product for a semiconductor manufacturing process, it may be eighteen months before you see your first revenue because that is how long the semiconductor manufacturing cycle lasts, and your product will not become part of the process until the next cycle.

If you’ve created a revolutionary anti-aging skin cream, you may be to grow your revenues exponentially, but there will be a significant marketing and sales budget behind that growth that will have to be accounted for in your expenses. And note, those sales and marketing dollars will have to be spent before you see a dime of revenue.

The next section is the cost of goods sold (COGS). Historically, COGS are the costs directly related to the purchase or production of whatever your company sells. I have also seen a clever play on the acronym for service companies: cost of services generated.* If you sell time of your employees, you could list their time and allocated overhead as cost of services generated.

The next section is gross profit. This is your revenue minus your COGS. Your gross margin is the gross profit divided by your revenue times 100. This number can be compared with other companies in your industry to give you a sense of your competitiveness. If your gross margin is wildly out of line with your competitors, you need to figure out and understand why.

The following section shows your operating expenses. This is usually the section where novice entrepreneurs get into trouble. Included here would be your depreciation, your sales and marketing expenses, and your general and administrative expenses.

Sales and marketing

* Personnel costs (with overhead of 20-30%): Sales, marketing and business development, plus any support personnel
* Commissions
* Collateral and promotional materials
* Travel and entertainment costs
* Trade shows
* Advertising
* Branding

General and Administrative

* Personnel costs (with overhead of 20-30%): Executives, HR, IT, admin
* Insurance costs aside from health care: property, liability, key man, umbrella, etc.
* Rent: include both monthly and annual operating assessment
* Utilities: power, telephone, internet, cell phone, cleaning services, garbage disposal
* Non-sales related travel and entertainment
* Office supplies, postage & shipping
* Legal and accounting costs
* Other misc

Note that overhead can be broken out separately, including such items as payroll taxes, workman’s comp, unemployment insurance, health and dental insurance, other employee benefits, etc.

Subtract the operating expenses from the gross profit to get your net profit or earnings before interest and taxes (EBIT). Divide your EBIT by your revenue to get your net profit margin.

You are unlikely to have extraordinary items when projecting an income statement, but if you do, they would go here, followed by the interest earned/paid section and the taxes section.

After subtracting out your interest and taxes, you would have the company’s net profit.

When creating your income statement, think of every cost you might incur. Compare your S&M and G&A sections with those of public companies. Try to determine why your percentages are out of line, if they are. There is no reason why you cannot come up with a better way to do things and gain several margin points doing so, but make sure that you have not gained those point because you forgot to pay your employees health insurance.

* Note: I am discussing this purely on a business planning basis. Do not use any definitions or expanations in this article for tax planning or reporting purposes. See a tax accountant for your tax reporting

Ms. Worrall is the President of Worrall Consulting, LLC. Worrall Consulting is a finance and business strategy consultancy providing professional services to high growth, early stage companies. The company provides capital formation assistance, market research and business intelligence, and business planning strategy. More information about the company can be found at http://www.worrallconsulting.com . Additional financial and strategy advice can be found at http://www.cfoyourself.com

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