The Art of Startup Finance: Financial Processes – Your Income Statement

Kauffman Founders School, Bill Reichert, TheArt of Startup Finance, Financial Processes: Your Income Statement So in this module we're going to talk aboutthe financial processes of your business.

That encompasses the income statement andthe cash flow statement.

The income statement and the cash flow statement sit right on topof your balance sheet, on top of the financial foundations of your company.

So the balancesheet is a static snapshot of your company's health at any given point in time.

Your incomestatement and your cash flow statement show your financial processes.

And that's likea video of your business over a period of time.

And so while your balance sheet is asof a certain date your income statement is over a period of time.

First, of course, at the top of your income statement are sales or revenues.

One thingwe get from some first‑time entrepreneurs, they start calling sales the same is income.

And that's not right.

Don't call it income.

Income is at the bottom of your statement,not at the top.

Now below your revenues are your costs of goods sold.

The costs that youincur to make the product that you're going to sell.

It's the material you use.

It's thelabor you put into a building it.

Those are the costs of goods sold.

So you've got yourrevenues.

You've got your costs of good sold underneath.

You subtract cost of sales fromrevenues and that gives you your gross profit.

Your gross profit is the profit that you make,the difference between the cost and the revenues.

Your gross profit margin is the percentageof that profit measured against the sales number.

If you make something for $50 andyou sell it for $100, your gross profit is $50.

Your gross profit margin is 50 percent.

So sometimes entrepreneurs make the mistake of saying hey, if I sold it for $100 and Imade it for only $50, that $50 profit is 100 percent profit.

That's wrong.

The gross profit numberis calculated on the sale number, not on the cost number.

Get that right.

Investors loveit when you have a big gross profit margin.

So you'll hear investors ask what's your margin.

Because they want to know, is the fundamental structure of your business really profitable.

So we as investors, we like to see companies with a gross profit margin of 70 or 80 percent.

We hate it when a company has a gross profit margin of only like 10 or 20 percent.

Thatgives you very little wiggle room to grow your company if your margin is that small.

The next thing on your income statement are your operating expenses.

So that includesthings like your R/D and your engineering.

It includes your marketing and sales.

It includessome of your operation and administrative activities.

Traditionally accountants willsay, okay, you have this expense item which is called S.

G.

A.

S.

G.

A.

means selling, generaland administrative expenses.

They lump all of these different expenses into that onecategory.

That's not very useful to you as an entrepreneur.

As an entrepreneur you wantto be able to take apart the processes of your business into the important components.

I want you to manage your income statement the way you run your business, not the waya bookkeeper wants you to run your income statement.

Think about what are the criticalactivities of your business and then organize your income statement, operational expensesaccording to critical activities of your business.

Such as key activity is, building the product.

So put the R/D and the engineering together into one expense category.

How much do wehave to spend each month to build and maintain and support and continue to develop this product.

Administration also may be a separate activity.

What do you have to pay for the infrastructureof your business? You know, the rent on your building, the cost of your data lines andphones, things like that.

So you put together all of those operating expenses, you deductthose from your gross profit and that becomes your operating profit.

Your operating profitshows the profitability of your company's operations.

You know, a lot of what I've been saying about the income statement and the details of theincome statement sounds like a lot of work, right? So I really encourage you, don't takeit on yourself.

There's all these details of running a business that can overwhelm youas the entrepreneur.

I strongly encourage you, get a great office manager who can takecare of all of these details, can make sure that your books are in order and can keepyou focused on the most important parts of your business.

Well I mentioned before investors are really interested in your margins.

Particularly focuson your gross margin, obviously at some point they're going to be really interested in youroperating profit margin.

And finally your net margin, which is the net income margin.

So they're going to look at those numbers as indicators of how profitable you are andhow efficiently you're running your business.

But there are some other deeper dives thatinvestors are going to do into your income statement.

They are going to be looking forwhat we call operational efficiencies.

How efficient are you at running these processescompared to our other companies? So they are going to do ratios on, you know, how muchare you spending on marketing compared to your revenues, how much do you spend on salescompared to your revenues, and how do those ratios compare to other companies in yourbusiness and other companies in their portfolio.

So you're going to want to learn to look atthese ratios.

And you're going to want to focus on figuring outer how to get those ratiosin line with the expectations of investors.

And even better for your own sake, how canyou squeeze more profit out of your company by being even more efficient than you are.

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