Startup Financials – How To Read Income Statements
Startup founders, are you struggling on how to read the financial statements? It is not easy to make important business decisions that could sail or fail your company, yet with very little data you can rely on. Financials have been one of the most reliable data that executives have been using when making decisions. Here we will teach you the foundation on how to read financial statements and how you can use them to make important business decisions.
What are financials?
Financials is a short term for financial statements. The most common form of financial statements are Income statements, Balance sheets, cash flow statements, and forecast and budget. For this blog, we will focus on income statements and teach you the basics on how to read these statements and use it to make decisions.
What do you use Income statements for?
- Investor’s financial package
- Business decisions
- Bank loan
- Tax return
Income statements are also called profit and loss statements (simplified version is P&L statement). Don’t ask me why there are two different names for the same statement, I am as lost as you are on that one. However, if you use QuickBooks Online (QBO) as majority of the startup founders do, QBO calls income statements as profit and loss statements. So, you will want to remember that these two names are for the same statement. In this blog, we will call it Income statements just to make it easier.
Now that we understand what income statements are for, first things first, you need to set a time period for your Income statements. Most often you want to see the statements by year, month or week. We will use monthly income statements as an illustration, for example, the month of January, from Jan 1st 2020 to Jan 31st, 2020.
What do income statement tell us?
Well, getting to the point of it, income statements tell you if you have made money or not.
Income statement is composed mainly by two parts:
1. Revenue/sales
Revenue/sales is the first section of Income statements. It shows the total sales your company has made in a month. If you sell your services/products in a platform such as Amazon, Shopify or your own website, make sure the sales number from this platform and the sales number on your QBO are the same, or you will need to find the difference and fix it.
- Cost of Goods Sold (COGS)
COGS are expenses directly related to your sales. The more you sell, the higher your COGS are. COGS are displayed right under Revenue/Sales, and shows how much you have spent on making the products/services you sell.
2. Expenses
All the expenses here are called operating expenses (aka Selling, General and Administrative expenses, short for SG&A expenses). They are different from COGS, these expenses relate to your business operation. An easy way to tell the difference is that if you are not selling products/services today, you will still need to pay operation expenses for your business.
The main categories of the expenses here include:
- Full time employee salaries and employment taxes
- Marketing and sales
- Office rent, supplies, utilities and software
- Fixed asset depreciation expenses
You can rearrange the sequences of the categories based on your priority, there is no wrong or right answer on how you choose to see these expenses. To simplify things, we skipped expenses such as tax and interests which are important needless to say.
3. The last section is net income:
Net income = sales – expenses. Net income is what your company truly earned and can be distributed as dividend to shareholders. Also, it is the number that you pay taxes on.
CFO tips:
How often should you read Income statements?
This answer varies, but, the short answer here is as often as you need to. We recommend for startup founders, if you can’t read your financials daily, try to read it at least once a week. The reason is that you need to monitor your sales and expenses in a very frequent basis so you can adjust your strategy accordingly.
Can you get a burn rate from income statement?
Yes, the expenses on income statement is your burn rate.
How do you use income statement to control cost (or stick to your budget)?
You assign responsible personnel to each main expense. For example, you assign HR or CFO for the expense on Full time employee salaries, assign chief marketing officer for the expense on Marketing and sales, etc. The assigned personnel are responsible to stick to the budget, monitor the spending and make sure that the company is not over spending and over using the money on the planned activities.
How to increase net income?
You need to either increase your sales or lower your expenses or do both. Be sure to create a company culture that starts right from the beginning. This culture must be frugal on spending and relentless on chasing sales.
Takeaway:
Be able to understand Income statements and use it to make decisions. This is an important skill for founders to master.
In the next blog, we will teach you how to read Balance Sheet, which shows your company’s assets, liabilities and equities.
