16 SAFE & VAULT TECHNOLOGY | January/February 2023 www.savta.org BUSINESS SPOTLIGHT Demystifying Your Income Statement Note that because some business is done on credit, when we say “money in and money out,” this does not necessarily mean that we received payment of all our invoices or paid all our bills yet. Looking at this expanded top INCOME section enables us to determine that: We generated $525k in gross sales (what we invoiced). We had $25k in discounts, returns and allowances (DR&A), which reduced our sales for a net sales of $500k. (gross sales, less DR&A). our ‘direct’ cost (cost of sales or COS) of providing those sales was $300k. gross profit on sales is $200k *** (net sales, less cost of sales) gross margin (GM) is 40% (respectable for a typical service business). *** Your gross profit is what’s left over to cover operating ex- penses and overhead. Let’s dive a bit deeper into the cost of sales (COS) issue. If your company were a wholesale distribution business, you would buy products and then resell them at a higher price to make a profit. In this scenario, at the end of each month, you would know how much (and what) you sold, and you’d also know what you paid for those products. What you paid for the stuff you sold would represent your COS. In our distribution business, accountants would likely use the term “cost of goods sold,” instead of “cost of sales,” be- cause there isn’t any direct labor involved in generating these sales. You buy products (goods) and you sell those products (goods), hopefully at a profit. Thus, the term “cost of goods sold.” The same principle is used in a retail business. Note that in this section of the P&L, we refer to our costs rather than “expenses.” This is a very important distinction that helps to understand the COS concept! However, if you are a service business, you will likely be doing jobs that involve installations, repairs and other ser- vices that add or provide value. You’ll also likely be selling materials and/or products, either separately (such as over- the-counter sales, if you have a retail shop) and/or as part of your jobs or projects. We need to know what these jobs cost you, and that usually means primarily your direct labor plus materials used on those jobs. We need this cost data separated because, if we did not, we’d be unable to determine whether we were making money (or how much) from selling our services and/or products, before we considered the impact of operating expenses and overhead for our business. Again, it’s helpful to use the term “cost” at this juncture and use the term “expenses” later on. This gross profit (net sales less COS) tells us how much we have left over to pay for operating expenses and overhead such as rent, phone, utilities, salaries, payroll taxes, insur- ance, travel and other expenses of running the business (and also, ideally, some profit). But you will quickly see that this minimal level of detail does not really tell a business owner or manager much, except perhaps the final score of the game for a particular period of time. So, let’s add more lines for additional details to help us run the business. INCOME STATEMENT OF XYZ COMPANY For the period XXX (Typically for one month. Issued for each month of the year) INCOME: (Overarching category of all money that came in – earned) Gross Sales $525,000 (Sales before discounts/returns/allowances (DR&A)) Net Sales $500,000 (Services and/or products you sold, less DR&A) Less Cost of Sales (COS) -$300,000 - (“Direct” costs incurred, such as labor and materials) Gross Profit $200,000 (Net Sales, less cost of sales (COS)) Gross Margin % 40% (Percentage of gross profit from those sales) Figure 3. Adding a few details to this income statement helps paint a more complete picture.
