In this transcript Clay Clark, US Small Business Administration Entrepreneur of the Year, and Tim Redmond discuss the business income statement on Thrive15.com, a leading top-tier Ohio business college.
Clay: Tim Redmond, thank you for being here. I know that you know probably more about accounting than what you want to know about accounting.
Tim: I studied accounting. It was my major, accounting and finance because I knew I wasn't going to learn this on my own. I wasn't going to be reading at night to learn accounting so I forced myself to be an accountant. I was going to learn management and marketing because I'm interested in that but this I put myself through accounting, got a CPA, so I'm a constant pain in abdomen like we talked about before.
Clay: Here's the thing. A lot of thrivers watching this, very few people want to click on the accounting tab and go, "Oh man, this is ... "
Tim: But they're here. Look.
Clay: These are terms we have to know. This is kind of like a glossary. It's financial education. We have to know these basic terms or we're going to run around with ignorance, which is no excuse, and we're going to have a problem.
Tim: Ignorance is extremely costly, especially with financial knowledge. If you don't have financial knowledge, not learning how to read your financial statements is going to cost you money if you really don't understand what's going on.
Clay: The people are pumped so here we go. We're going to dive into it. We're going to talk about income statements. Balance sheets, cash flow statements, computing your profit margins, budgets and profits and auditing financial statements. Here we go, the fire hose of knowledge.
Tim: Let me start ... Let me framework this Clay.
Tim: I know we're trying to cram a lot in. We have to look at financial statements, not just as numbers. I'm just not into numbers here. When you're not into, what are those numbers? What do those numbers really represent? The numbers represent your decisions, your procrastination, your activity, your discipline, your systems or lack of systems. The numbers are the net result of decisions and actions that you and your organization have taken. They're very real. They're not just abstract. They're just the summation, the summary of who you are, what you did in your business. That's all we're talking about.
Clay: Keeping score.
Tim: Keeping score.
Clay: The income statement. Let's start there. The word income statement, technically, as defined by my main man Webster, he says this, "In accounting, the activity orientated financial statement issued by businesses. It's covering a specified time, such as 3 months or a year, the income statement is a summary of revenue and expenses. It also lists gains and losses from other transactions, such as the sale of assets or the repayment of debt. Standard accounting rules govern the procedures for recording of each item." What are we talking about?
Tim: An income statement is really, to boil it down, is it records your sales of your business and the expenses related to those sales. That's all we're talking about.
Clay: All we're talking about is the stuff you sold and the things that
Tim: We're in business to sell stuff and maybe a service, maybe a product, a combination of both. We're going to record the sales of those things and the expenses attached to make sure we can get those sales done.
Clay: How do I go about setting up an income statement?
Tim: Can I come to the board here?
Clay: Yeah, the czar of the telestrator.
Tim: When we are talking about an income statement, we have to think about it being 3 main elements. We have the sales. Sales are what we sell. You want me to cover that again or do you think you understood ... ? You understood that the first time around?
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Tim: Sales are what you sell as a product or service. Expenses are the money ... The sales are the money coming into you, expenses are the money going out of you. That's the cost to make sure the sales actually happen. What you have left over is you have the net income. Hopefully it's a net income. If your sales is greater than your expenses, then you have net income. If your sales is less than your expenses, your expenses is greater, you have a net loss and your headed towards having fights with your wife and kicking your cat. Those 2 things happen quite a bit.
Clay: Fights with your wife and kicking your cat. That's what happens when your sales are less than your expenses.
Tim: That's right. We're going to go into an income statement. An income statement like Nate said, my good friend Mr. Webster said, is income statement is the activity over a period of time. It may be a month. It may be a day. It may be a year. It may be a decade. Whatever you want to do, you want to measure your activity. How many sales do you have?
Let's say we have sales of $1,000 during our month here of recording this. We have different types of expenses here. We have the costs of good sold. Then we have the operating expenses. Here we're going to see this. Sales is $1,000. Let's say that I'm selling desks. Let's say that I sold that desk for $1,000, but it cost me $300 to buy that desk. You've got a little bit of a markup, but hey, we're in America, we're going for the profit.
The amount of money we have after we took the amount of money it cost us to get that desk is $700. That is the gross profit. I don't think it's very gross, I think it looks pretty. We want the gross profit to be as high as we can. We see here that we have a gross profit of 70%. Then we have expenses. We have to hire people to sell the desk, to ship it over to do all that. Let's just say we have expenses of $100. We have utilities, the utilities cost $150 here and advertising, we spent $50 on that.
Our total expenses right here are $300. What we have here is we have our sales, the cost to get that sale, we have gross profit. We have all of our expenses here. We have the expenses that comes down $300, less than $700. We made a net income of $400.
Clay: $400 on the desk that we sold.
Tim: $400, right. We have to make sure ... What happens here Clay, is a lot of business owners don't understand all the expenses that go into what it really costs you to sell this desk. They say, "Hey listen, I bought it for $300, sold it for $1,000. I got $700. I'm $700 richer. I'm going to go spend this $700.
Clay: You see it all the time.
Tim: They don't understand all the other expenses that go into making sure you can sell that desk.