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If you’re starting a business in Utah this year, you probably already know you’re in the right place. Utah ranks third on CNBC’s America’s Top States for Business 2021 list, earning high marks under the categories of Infrastructure, Economy and Business Friendliness.
But if you have a passion for macrame or manicuring lawns but not for math, you may not yet have a solid idea of the financial aspects of your business plan. Before investors or bankers will agree to fund you, they need to know whether your business will be profitable or not. They’ll want to see an income statement or profit and loss statement (P&<). That statement covers revenue, cost of goods sold, gross margin, operating expenses, operating income and bottom line. Here is some more information about each of those elements:
Revenue
Revenue is the amount you are bringing in from sales before any expenses are taken out. The lower this number, the lower your expenses need to be. Revenue is essential.
“Without [revenue], your company cannot earn a profit and stay viable in the long run,” said Neil Kokemuller in a published article for AZ Central. “You need to collect revenue to justify the fixed and variable expenses you pay just to operate a business. In simplest terms, zero or low revenue leads to an unprofitable business and negative financial results.”
Cost of goods sold
The cost of goods sold (COGS) refers to how much you are spending on making your products or delivering your services. This includes all of the expenses that go towards producing goods or services but does not include indirect costs like overhead or sales and marketing.
What if you are selling items online? Let’s say you have a business that resells used clothing. If you have unique packaging that would appear on a shelf if your business had a physical location, that would be included in your COGS. But the tape and cardboard used to ship the items would not be included, nor would the cost of shipping, according to Sean Ross at Investopedia.
Gross profit and gross margin
How much money do you have leftover to cover expenses? To find out, take your revenue and subtract COGS. This is your gross profit. Then, to figure out your gross margin, divide your gross profit into your total revenue.
For example, say you generated $50,000 last quarter and your COGS was $30,000. Your gross profit would be $50,000 minus $30,000: $20,000. Then, to figure out your gross margin, you divide your sales of $50,000 by $20,000 and multiply by 100. Your gross margin would be 40%.
Knowing your gross margin helps you know if you’re improving from quarter to quarter. And if you know the average gross margin in your industry, that gives you an idea of how you compare with your competition.
Operating expenses
Operating expenses tell you how much it costs to keep your doors open. This includes insurance, utilities, office supplies, advertising costs and more. To calculate this figure, subtract your COGS from your total expenses. When you track your operating expenses, you can better keep them under control and maximize your profit.
Operating Income
“Operating income is a measurement that shows how much of a company’s revenue will eventually become profits,” said Adam Hayes at investopedia.com. Why is this important? Because “many companies focus on operating income when measuring the operational success of the business.”
For example, Company A might see their operating income rise by 30% year over year. Since the company is looking to merge with Company B, this operating income growth gives Company B shareholders confidence that the merger is a good idea, even though Company A’s first-quarter sales fell by 2%.
You can calculate operating income by subtracting your operating expenses from your gross income.
Net income
Net income is “a company’s total revenues minus its costs, expenses, and taxes,” according to Merrill Financial Associates, an investment strategy firm in Provo. “Net income is the bottom line of a company’s income statement (which may also be called the profit and loss statement).”
With revenue as your top line, your bottom line is your revenue minus COGS, operating expenses and any other expenses. This figure is important because it tells you how much revenue your company is retaining.
When you put your revenue, cost of goods sold, gross margin, operating expenses, operating income and bottom line together, you can create a profit and loss statement that will show investors and bankers just what they need to see. And with a better understanding of your business’s financial situation, you can make better decisions. So, entrepreneurial daydreamers, don’t let the numbers get you down! It’s simpler than you think.
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