Money Monday #1 - Parts of an Income Statement
Updated: Jan 10
Welcome to the first Money Monday! It's a little later in the day than I intended to write this - incidentally because I was busy working on other finance things through the day!
I want to use the Money Monday series to dive into financial things - definitions, metrics I look at when analyzing financials, and my take on finance things out in the world. Before we do that, I feel we should start with some basics - so let's start really simple and review the main parts of an income statement.
But before we even do that, what is an income statement? An income statement is one of the key pictures of a company's financial health. While it doesn't tell the whole story by itself, the income statement gives you a sense of how much money a company made during a certain period - usually a month or quarter (3 months). Sometimes, it will tell you how the company made that money, and it may even give you some insight into how things have been trending. Put very simply, an income statement is a numerical snapshot of how much money a company brought in through revenues, and how much it spent while acquiring that revenue.
Now, let's get into the main sections of the income statement.
In a standard income statement, the first thing you'll see is revenue. This is how much money a company made in a reporting period from its operations. This might be sales of products, consulting hours, or some other fee-for-service revenue. In general, revenue is derived from a price per item or service, multiplied by the quantity of items sold or units of service sold.
If any discounts are applied during sales, that's usually recorded as a 'contra' revenue item and subtracted from total revenue. The resulting number is called 'net revenue,' which is the real amount of money a company made top line.
Cost of Goods Sold (COGS)
This section can be a bit contentious. While there are accounting principles that guide what counts as COGS, financial professionals often push the definition as much as possible to make their financials look good.
Cost of Goods Sold, or COGS, is a measure of the costs necessary to make sales. These are mostly your variable costs that increase directly with revenue. In a physical product-based business, these might be material costs. For example, if your company sells cardboard boxes, the cost of the cardboard itself might fall into COGS. The more boxes you sell, the more cardboard you need, and therefore the higher your COGS expenses.
COGS are critical as if COGS per unit exceed net revenue per unit, then no matter how many units you sell, your business will lose money. COGS also help determine Gross Margin, which is a measure of how much money a company has left after subtracting costs needed to make sales. We'll talk about COGS and margin in more depth next week.
Overhead expenses are your expenses not directly related to making a sale. Often called operating expenses, or OpEx, these could be admin employee salaries, rent, or things like meals and entertainment. These costs don't necessarily rise as revenue increases, and in fact, it's generally a goal to grow revenue more/faster than you grow OpEx.
What's left after subtracting OpEx from Gross Profit (Net Revenue - COGS) is known as EBITDA (earnings before interest, taxes, depreciation, and amortization). We'll cover EBITDA in more depth in a few weeks, but EBITDA is often considered the most important number on an income statement. It represents if a company is making money after subtracting all operating costs, without worrying about things like taxes or interest expenses (both of which can messed with via various strategies).
After EBITDA, you have 'ITDA.' I've never really heard anyone call this section 'ITDA' but that's essentially what's left. Taxes, depreciation, amortization, and other income/expenses. For many businesses, especially small or software based businesses, this section is usually pretty minimal. But if you have interest income from money sitting in a bank account, or interest expenses from borrowing money, those would get recorded here.
Finally, after adding any income from the 'below EBITDA' section, and subtracting any expenses from that section, you're left with net income - the amount of money made or lost after subtracting all expenses needed to support the revenue. In venture backed businesses, Net Income is often negative, meaning the company is still spending more than it makes, hoping that they have enough cash in the bank to scale revenue to a point where all costs are (more than) covered.
Those are the high level elements of an income statement. To put it extremely simply, an income statement starts by sharing how much money came in via revenue. It then subtracts expenses needed to make that money. And finally, it shows the difference between the revenue and expenses, illustrating if the company made money or lost money (dipping into its cash reserves).
As mentioned above, we'll do a deep dive into a few of the elements of the income statement in the coming weeks. If you have any questions in the meantime, or want to see me cover a specific topic, please do reach out here.
Talk to you tomorrow for our first edition of Tech Tuesdays!