Income Statement Basics

I know it’s starting to get chilly out there for a lot of us, but this week we’re sticking with the summer reboot and doing a five-minute finance lessons on the basics you need to know about your income statement, otherwise known as your profit and loss or P&L statement.

Since I work with first-time entrepreneurs who don’t typically have any background in business management, I spend a lot of time talking with my clients about financial statements and getting them up to speed on what’s what. Now, clearly, nobody is going to become an accountant overnight – nor should you try to – but every business owner should have enough knowledge to understand what an accountant is telling you about the financial state of your business and to be able to read basic financial statements yourself and get the pulse of your business’ health. So, as step one towards that goal I’m giving a series of three five-minute finance lessons to give you a brief overview of the three basic financial statements: the income statement, the statement of cash flows, and the balance sheet. This week, we’re covering the income statement.

The income statement, also known as the profit and loss or P&L statement, shows the company’s revenues and expenses over a specified period of time. It’s a bit more of a story than the static picture of the balance sheet and will be labeled accordingly: for example, Company X Income Statement for the period January 1 -December 31, 2013. The income statement is typically divided into operating and non-operating sections, though many new businesses don’t really have non-operating expenses and don’t separate the income statement in this way. The operating section should include all of the revenues and expenses that are directly related to what the business actually does. The non-operating section, by contrast, includes all of the revenues and expenses generated from any activity that is unrelated to the business’ primary operations. For example, if a business has some extra cash lying around and invests it instead of putting it back into the business, any broker fees, etc. associated with the investment and any profits made from it would fall in the non-operating section. Another example would be if a non-real estate company sold one of the buildings it owns – all of the costs and revenues associated with the sale would fall under the non-operating section. Again, these types of revenues and expenses are far less common in brand new businesses, so many business plans don’t include a non-operating section on their income statement.

Of course, the actual line items included on any income statement vary widely from company to company but it is always broken down into revenues and expenses. Expenses will be further broken down into cost of sales and selling, general, and administrative (SG&A) expenses. Cost of sales includes cost of goods sold, which are the direct costs of whatever you sell, plus any additional costs directly associated with the sale. For example, if you are a reseller of widgets and each widget costs you $10 to buy plus you need to package it for an additional $1 and you pay a sales commission of $2 for every widget sold then your cost of goods sold on one widget is $11 and your total cost of sales on one widget is $13. SG&A expenses are those that exist separate from any individual sale. You can think of these costs as the overhead costs of doing business. You need to pay your utilities bills, administrative salaries, rent, etc. whether or not you make a single sale, so these expenses cannot be included in the cost of sales but are, obviously, important to include in the income statement. They will come in under the selling, general, and administrative expenses section.

You’ll then subtract all of the expenses from all of the revenue and subtract out taxes, interest payments, depreciation, and amortization to get your net income for the period. Take a look at the example to walk through the income statement line by line and get a better understanding.


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Business Basics Review: 5 Minute Finance Lesson

I’m on vacation this month so we’re getting back to basics and sharing some of my old videos that have been most helpful in setting new entrepreneurs on the path to successfully planning and launching their new startups or small businesses. This week’s old school video: the 5 Minute Finance Lesson.

Startup Misconceptions: Raising Venture Capital Means You’ve Succeeded

In my effort to provide useful information to entrepreneurs and aspiring entrepreneurs, I share tons of interesting and helpful articles that I find around the web and think can help answer questions for my followers and help you all move your businesses forward. Often, people write asking me to elaborate on those articles or pieces of those articles so I am starting a series that will do just that. I may combine a few or leave a few out here and there, but I will cover the topics that people most often asked me to elaborate on.

I recently posted an article from RockthePost about common misconceptions people have about launching a new company. The next of those misconceptions that I want to tackle here is the idea that raising funding means you’re a success.

As it’s portrayed in the media, venture capital, startups, and entrepreneurship are all about glitz, glamour, and overnight riches. Because of this, and because of the size of some of the checks that venture capitalists might turn over to entrepreneurs, many new entrepreneurs operate under the misguided idea that raising venture capital money is the goal and that doing so means you’ve succeeded.

The reality, however, is that venture capital investment is not the end goal. By its very definition, it is an investment in the future success of the business. That means that when a VC writes you a check, she’s is saying that she sees success in your company’s future, not that you’re a success right now. If you’d already arrived, how would the investor make money by realizing gains on the increased value of your company?

When viewed in this light, it’s clear that raising venture investment is just one stepping stone on the road to success, and it’s a stepping stone that costs the entrepreneur power, ownership, and control.

Clearly, successfully raising venture capital is an accomplishment and I am not saying that it’s not. It’s great to get the validation of seasoned investors, to know that others believe in your vision and in your ability to achieve it, and to have enough money in the bank to keep the lights on for another month. If you’ve just recently gotten funding, congratulations! You absolutely deserve to celebrate. However, the party shouldn’t last too long because you haven’t succeeded yet. You have to get back to work. Your investors are going to hold you accountable for hitting your milestones and you’ve given up ownership, so you need to increase the value of your company by at least as much as the value of that cash infusion before running through that cash just to get back to where you were. The VC’s check being deposited into your business account does not mean it’s time to kick up your feet.

If you haven’t yet raised venture capital, take the time to step back and honestly evaluate why you’re pursuing the investment and whether or not it’s the best course of action for your business. This isn’t rocket science but BAD reasons to pursue venture capital funding are:

  • You think it will make you look cool
  • You want to be able to pay yourself a 6-figure salary for the same work you’re doing right now
  • You think all startups are supposed to raise VC money

On the other hand, GOOD reasons to raise venture capital funding might include:

  • You’re building your business in an industry with high startup costs and venture funding is the only way to get the necessary amount of money
  • You’re experiencing very rapid growth and in order to maintain that momentum, you will need a quick infusion of a lot of cash

If you’re not sure what type of funding is best for your business, don’t chase venture capital just because it’s the most talked about. Less than 1% of all new businesses in the U.S. are funded by angel investors or venture capitalists and if it’s not the right type of investment for your company you’re going to regret chasing it. For a quick overview of the different types of funding available to new businesses, check out my previous post on just that.

The right type of funding is critical to the success of your business, so make sure you’re making a strategic decision about whether to pursue outside investment and what type of investment to pursue as opposed to making a vanity decision based on the perceived “street cred” of a venture investment. And, if you do raise venture capital, be sure to remember that raising that money means you just won a battle, not that you’ve already won the war. Congratulate yourself and then get back to work!


Once you’ve assessed what type of investment would be best for your business, let me know in the comments section below what your strategy is for attaining it.

If you like this video, please let me know by giving it a thumbs up on YouTube and Facebook and, if you think others would find it helpful, remember to share it on social media. Thanks for watching and we’ll see you next week on New Venture Mentor.

The Benefits of Bootstrapping Your Small Business or Startup

If you follow me at all, you know that I am a huge proponent of bootstrapping your business if at all possible. While raising outside investment from a venture capitalist or an angel may be the glitziest way to go, it’s not right for the vast majority of businesses. If you need a large sum of money in order to achieve the rapid growth that you know your company is capable of and can generate huge returns for an investor, by all means get your strategy together for raising VC money. However, for most of you entrepreneurs out there, you’ll just be spinning your wheels because the business you’re building is not suited for that type of investment.

Somehow over the years raising venture capital has become seen as a success in and of itself as opposed to another step on the journey to success, which means everyone wants to raise it, whether or not they should. Therefore, just to make sure that any of you who won’t be raising VC cash don’t get distracted by the glitz of VC land, here are some of the benefits of bootstrapping that entrepreneurs should take full advantage of if they have the option.

Firstly, bootstrapping is the only real way – with the exception of rewards crowdfunding – to maintain complete ownership and control of your business without taking on debt. If you want to be able to steer the ship based on your goals alone without being bogged down by principal and interest payments that may come due before you’re generating revenue, you have to maintain complete control. When you bring on VC investors, they take equity in your company and seats on your board and you are no longer the only leader at the table. You will be forced to take into account how your investors want things done and, depending on the deal structure, may legally need their permission for decisions about how to manage and where to take your company.

Similarly, if you want to build a long-term business, perhaps one that you can pass down to future generations in your family, you don’t want to look at divvying up ownership and control to outside investors because they will expect a quick profitable exit – a completely different goal. Bootstrapping gives you the option to remain in control or try to make a profitable exit and the only person who you need to get onboard with your decision is you.

Next, when you bootstrap you learn to be thrifty, creative, and efficient. Every single penny counts, so you’re not wasting time on stuff that doesn’t matter or you’ll go out of business. Raising too much outside funding can actually have the effect of making a company inefficient – not just in the sense that they spend a large chunk of their time courting investors and then trying to keep them happy, but because the founders now have more funds to play with and less skin in the game. While most don’t intend to slack off just because they’ve raised a round, having a long runway and a buffer to fix mistakes takes away a certain level of urgency and typically leads to a less efficient utilization of the capital available.

Finally, if and when you do succeed, knowing you literally built the entire thing yourself and that you don’t have to split the bragging rights or the cash with anyone will be an incredibly sweet feeling. If you jump into too many rounds of venture funding, you’d be surprised at how quickly you can dilute your power, control, and payout once you finally do sell or IPO. I’ve heard many stories of entrepreneurs who sold their companies for 7 or 8 figures but only walked away with a few hundred thousand dollars after years of hard work.

Once again, there are certain circumstances when raising venture capital is the best decision for your business, but for the vast majority of companies, bootstrapping is a more beneficial option and you should be careful to weigh the pros and cons of each before focusing your energy on raising money instead of building your business.

Now I’d like to hear from you. What are the best reasons you can think of for bootstrapping instead of raising outside capital? Let me know in the comments section below.

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The Basics of Cash Flow Analysis for Startups and Small Businesses

Everyone’s heard the refrain “cash is king” when it comes to running a small business and it certainly can be true. There are many new or small companies that are profitable but are still forced to close their doors because they didn’t manage their cash flow appropriately. That’s why careful cashflow analysis is incredibly important when you’re running a business.

Cash flow analysis is basically keeping track of when and how cash flows into or out of your business. This is different than just tracking your revenues and expenses because revenues and expenses should be tracked based on when money is earned or spent, not when it’s actually received or paid out. Depending on your business, your clients may not pay you for up to a couple of months after you’ve already delivered a service or product, so you have technically earned the revenue, but you don’t have that cash in the bank to pay your bills.

 There are 3 types of cash flow in any business: cash flow from operating activities, cash flow from financing activities, and cash flow from investing activities.

Cash flow from operating activities is that related to the core business and you’ll be able to use the income statement to figure out the cashflow from operating activities by taking the net income and adding back in expenses like depreciation that are not actual cash outflows and adjusting for accounts receivable and payable – cash that has been earned or spent but hasn’t actually been received or paid.

Cash flow from financing activities is that which is related to – surprise – financing activities – things like loan payments you make or payments you receive from loans made to others.

Cash flow from investing activities is that associated with any investments the company has made like the purchase or sale of land or equipment.

A statement of cash flows is one of the three basic financial statements but somehow still gets overlooked by many entrepreneurs. If you’re not familiar with it, you should speak with your financial officer or accountant to get an understanding of what your business’ cash flow looks like. You can also buy my business planning book and review the section on creating financial projections to develop your understanding of the importance of cash flow and how to determine and analyze it. You can get the Kindle version here and other ebook formats here.

Basically, cash flow will give you an idea of the financial health and liquidity of your business by showing you what you actually have available to use to meet the company’s obligations. $1 million dollars in profits isn’t as awesome as it sounds if your cash flow is such that you can’t pay your rent and will be evicted before you can ever collect that $1 million. You need to make a point of regularly reviewing your cash flow and making any adjustments where necessary to improve the health of your business. If you spot some problems, try taking a look at my old video for some tips on how to improve small business cash flow.

The Importance of Maintaining Good Personal Credit as an Entrepreneur

Entrepreneurs understand that they need to keep their business’ finances in order if they’d like to obtain a business loan in the future. However, many are not aware that it’s imperative to keep their personal finances in tip-top shape as well.

There seems to be a major misunderstanding among small business and startup owners about the requirements for obtaining a business loan from a bank. I have seen many entrepreneurs not realize that even if the business is formed as a corporation, they will likely still need to provide a personal guarantee in order to get a loan. That means that their personal credit will affect whether the business gets approved.

Confused about why that’s the case? Watch this week’s video to learn more about why it’s so important that business owners maintain good personal credit in addition to keeping their company’s finances in top shape.