Understanding the Income Statement (December 1, 2024)

The Income Statement, also known as the Profit and Loss (P&L) Statement, is one of the most essential tools for understanding your business’s financial health. It provides a detailed look at your company’s performance over a specific period, such as a month, quarter, or year. To successfully manage your business, it’s critical to not only understand the Income Statement, but you should also be using it to guide informed business decisions.

Breaking Down the Income Statement

The Income Statement consists of several key components:

1. Revenue (Top Line)
   This is the total income your business generates from selling products or services. It sits at the very top of the Income Statement and serves as the starting point for evaluating financial performance.

Keep in mind that not all revenue is created equal. Some businesses might have a single, steady revenue stream, while others may have multiple sources, such as recurring subscriptions, one-time sales, or project-based income. Analyzing these streams individually can provide even deeper insights into your business’s success.  Therefore, if this is the case with your business, you should make sure that you have separate line items on your Income Statement for each revenue stream so that you have data to review.

2. Cost of Goods Sold (COGS)
   COGS includes all the direct costs associated with producing your products or delivering your services. For a manufacturer, this might include raw materials and labor as these are all components that go into the product(s) you manufacture. For a service business, it could include salaries for the employees providing the service since that is the product that you create.

3. Gross Margin
   Gross Margin is what’s left after subtracting COGS from revenue. For example, if your revenue is $100,000 and your COGS is $60,000, your Gross Margin is $40,000—or 40%. This metric measures how efficiently your business turns revenue into profit before accounting for operating expenses. A declining Gross Margin could signal rising costs or inefficiencies.  Showing both the amount of the Gross Margin and the percentage is typical.  The standard for Gross Margin will vary based on your company’s industry.

4. Operating Expenses
   These are the indirect costs involved in running your business. These include expenses like salaries for administrative staff, rent, utilities, marketing, and software subscriptions. While they don’t directly contribute to producing your products or services, managing these costs effectively is essential to maintaining a healthy and efficient operation.  Also, you may not be able to control some of these costs such as rent or utilities, but you should have full control over other operating costs such as marketing expenses.

5. Net Income (Bottom Line)
   Finally, after accounting for all expenses, you arrive at Net Operating Income (NOI)—your profit or loss for the period.  This is derived by subtracting your Operating Expenses from your Gross Margin.  This is often referred to as the “bottom line” because it appears at the bottom of the Income Statement.

A positive NOI indicates a profit, while a negative figure means your business operated at a loss. But this isn’t just a binary measure of success or failure—it’s a powerful tool for uncovering areas for improvement or avenues for growth.

Why the Income Statement Matters

The Income Statement isn’t just a record of past performance; it’s a strategic tool. It reveals how revenue, costs, and profits interact, providing clarity on potential bottlenecks or growth opportunities.

Regularly reviewing your Income Statement allows you to:

• Spot trends: Are your sales growing? Are your costs rising? Identifying trends early allows you to make strategic adjustments.
• Evaluate profitability: Even if your revenue is increasing, are you keeping enough of it as profit? The Income Statement can reveal if higher sales are being offset by rising expenses.
• Set goals: Use past performance to set realistic revenue and expense targets for the future.  This is commonly referred to as “Budgeting” something all companies should do.

Best Practices

1. Regular Review: Don’t wait for tax season—you should produce and analyze your Income Statement monthly.
2. Focus on Metrics: Pay close attention to Gross Margin as it’s a strong indicator of your business’s financial health.
3. Compare Periods: Analyze trends over time to spot growth opportunities or identify potential problems early.
4. Consult an Expert: Someone with expertise in business finance can help you to review your Income Statement and identify opportunities to enhance your business’s profitability.

Taking the Next Step

Interpreting an Income Statement can feel overwhelming, especially if finance isn’t your area of expertise. That’s where a fractional CFO can help. Offering high-level financial expertise at a fraction of the cost of a full-time CFO, they can guide you in understanding your financial statements and turning them into actionable strategies to grow your business and improve profitability.

If you’re ready to take control of your business’s financial health and drive growth, let’s have a conversation. I’d love to help you unlock the full potential of your Income Statement and provide the insights needed to guide your business toward greater success.

For reference, here is a simplified example of an Income Statement for a fictional manufacturing business:

Optimizing Your Business:

Clearing the Clutter to Save Money and Improve Efficiency (November 1, 2024)

Running a business is a full-time job in itself, but taking a step back to evaluate how efficiently your operations are running can make a huge difference in your bottom line. Many business owners get so wrapped up in day-to-day operations that they overlook one of the most critical aspects of running a healthy company—optimization.

Whether it’s inventory, software, or other resources, businesses that regularly audit and optimize their operations tend to be more profitable and resilient. Let’s look at a few examples that highlight the importance of this practice, and how ignoring these details can result in inefficiency and lost profits.

The Cost of Excess Inventory: More Than Just Lost Sales

One major area where businesses often lose track of their costs is inventory management. Recently, at a networking event, I spoke with Stan, a seasoned business advisor, about a client of his—a product-based business that adopted a “no-discount” policy. The owner believed that holding firm on pricing, without running any sales or promotions, would protect the brand’s image. At first glance, this seems like a sound strategy, reinforcing the value of their products.

However, this well-intentioned stance created a critical problem—overstock. The company found itself sitting on large quantities of unsold inventory that couldn’t move, taking up valuable warehouse space. Their strict pricing policy meant that items, especially the lower-demand ones, accumulated in the warehouse. This added to their overall costs since they had to pay for the space to store products that weren’t selling.

Think about this from an operational perspective. For every month that excess inventory sits unsold, the business is not only tying up cash flow but also paying for storage. The situation worsens as inventory turnover slows. Over time, these products become obsolete or outdated, especially in industries where trends or seasonal demand can shift quickly. The opportunity cost of having capital locked into slow-moving inventory is immense, and it takes a toll on profitability.

In Stan’s client’s case, the owner failed to realize that inventory has an ongoing cost associated with it—even if you already own the products. If you need space to store them, that’s an additional expense. It doesn’t stop there. In some cases, businesses may even need to purchase additional racks or rent extra storage units to accommodate excess products, increasing costs even further.

The Win-Win of Employee Appreciation and Inventory Management

By contrast, I had the pleasure of working with a company that found a creative way to solve the excess inventory problem while boosting employee morale. This product-based business also struggled with overstock, but instead of holding firm to pricing policies, they took a more flexible, employee-centered approach.

Every Thanksgiving, the company shut down their warehouse for a few hours and hosted a celebration for their employees—a thoughtful, morale-boosting event that allowed the staff to enjoy a catered meal together. But they took it a step further. As part of their holiday tradition, the company held an employee-only Christmas sale, offering their staff the chance to buy low-selling items at deep discounts.

This strategy was a win-win. Employees were able to purchase gifts at a fraction of the regular price, and the company cleared out inventory that otherwise would have taken up space in the warehouse. The discounted sale not only reduced the company’s carrying costs for that inventory, but it also generated goodwill and increased employee satisfaction.

This creative approach to inventory management shows that businesses don’t have to choose between operational efficiency and employee engagement—they can achieve both simultaneously with some thoughtful planning. If you can free up space in your warehouse while improving employee morale, you’re optimizing not just for cost savings, but for a happier and more motivated workforce.

The Real Costs of Carrying Excess Inventory

It’s easy to think that inventory costs stop once you’ve purchased the products, but the reality is more complex. Carrying costs can represent a substantial financial drain if not managed carefully. These costs include not only the physical space for storage but also insurance, taxes, and the opportunity cost of having capital tied up in unsold goods. As inventory piles up, businesses may be forced to expand their storage capacity, which often leads to unnecessary expenditures, such as purchasing more racks or renting additional warehouse space.

Imagine a business that runs close to capacity in its existing warehouse space. When it gets to a point where there’s no room for new inventory, the company faces a choice: either lease additional space or invest in vertical storage solutions like extra racks. Either of these options can result in significant costs—costs that could have been avoided had the business managed its inventory better in the first place.

This brings us to a key point: businesses need to treat excess inventory as more than just unsold products. It’s a financial liability. By holding onto low-demand items, companies reduce their ability to focus on higher-margin or more popular products, which could generate stronger sales and cash flow.

Reducing Software and Subscription Redundancies

Inventory isn’t the only area where businesses get bogged down with inefficiencies. Software and service subscriptions are another common culprit. Over time, many businesses adopt multiple tools and platforms to handle different aspects of their operations—everything from accounting to project management to CRM systems. But without proper oversight, these software solutions can accumulate to the point where businesses are paying for services they no longer use or that overlap with other tools.

This type of redundancy can be difficult to spot, especially in a busy organization where departments may operate independently. However, each overlapping tool represents an additional cost that eats away at profitability. For instance, I’ve seen businesses paying for both a legacy system and a newer, more robust platform because they never fully transitioned to the new software. Instead of streamlining operations, they end up carrying the costs of both systems.

We’re now seeing consumer-oriented tools that help individuals track and cancel unused subscriptions—services like these are becoming invaluable in the business world as well. By performing software audits and streamlining the number of tools your company uses, you can eliminate redundant costs and make your business more efficient.

A Holistic Approach to Business Optimization

The underlying principle here is simple: optimizing your business means taking a hard look at everything you own or pay for—whether it’s products, software, or other resources—and evaluating whether those things are helping or hurting your bottom line. Regular audits of your inventory and software can reveal redundancies, inefficiencies, or outdated solutions that are quietly costing your business more than you realize.

By addressing these issues, you not only free up financial resources but also physical and mental bandwidth that can be redirected toward growth initiatives. This can mean expanding your product offerings, investing in new technology, or simply improving customer service.

Conclusion: Take Action Before Inefficiencies Take Over

Optimization isn’t a one-time event; it’s an ongoing process. Whether you’re dealing with excess inventory, redundant software, or other inefficiencies, regularly evaluating your business operations is essential for maintaining profitability and operational efficiency. Businesses that proactively seek out and eliminate these inefficiencies are not only more profitable, but they are also better positioned to weather economic downturns or shifts in their markets.

If you’re interested in exploring how CFO On The Go can help you take a closer look at your business’s operations and improve your bottom line, reach out to me at (737) 314-0060. I’d be happy to discuss how we can optimize your business for long-term success.

Ignorance or Negligence? (October 1, 2024)

Having the right information about your business is important.  For the financial aspects of your business, there are certain key indicators that you, as a business owner, should have readily at your disposal.  You should have in easy reach information about:

• how much cash you have
• your payables (what you owe others)
• your receivables (what others owe you)
• your profitability

This is not intended to be a complete list, but it is a good place to start.

Suppose you have ignored your business finances and know none of this information.  That happens more often than people outside of the business think.  I recently worked with a client who was headed down the path of running out of money before contacting me.  They had no idea that they were potentially facing insolvency if they did not take immediate action.

Q:  Is this a situation of ignorance or negligence?

Clearly, they are claiming ignorance as they just did not know they were running out of money.  The person trusted with managing company finances proved to be bad at their job.  A year ago, they were unaware of information that was easily discernable and knowable that clearly indicated that cash flow problems were on the horizon.  If they had known, they could have sounded the alarm bells and bought a lot of time to correct course.  This would have saved everyone in the organization a lot of stress, to say the least.  Instead, they went along, ignorant of the reality they were already living in, and even recommended using what precious cash they had to invest during the past year into the business, rather than operate in cash preservation mode.

However, not knowing is not a valid excuse and will not allow you to avoid claims of negligence.  Cornell Law School’s Legal Information Institute defines negligence as:

…the failure to behave with the level of care that a reasonable person would have exercised under the same circumstances

One could easily argue that we would expect a reasonable person to know whether they are running out of cash or not (as opposed to being ignorant).  Your employees depend a lot on you knowing how to run your business including your ability to manage company finances (or delegate that responsibility to someone who can do this for you).

So, I would argue it is a combination of both.  Just because you do not know (ignorance) the exact financial state of your business does not remove your fiduciary responsibility to manage company finances (negligence).  If company finance is a concern of yours or is not your strong suit, you might want to consider delegating that responsibility to a fractional CFO, which is an affordable option many business owners are turning towards.  If you are interested in exploring what that might look like for your business, please reach out to me at (737) 314-0060 and we can have a conversation about it.

Advice vs. Opinion (September 3, 2024)

In my profession, as a fractional CFO helping business owners to grow their companies, owners will often turn to me for advice and I am happy to provide it.  After all, it is one of the reasons they work with me so they can get access to someone with over 20 years of experience as a CFO.  However, there is a distinct difference between the advice I provide to my clients and my own opinions.

Normally, business owners want to know, “What would you do if you were in my shoes?”  Although this could be interpreted as asking for my opinion, in reality, this is a request for my advice or counsel. This is a request for what I would recommend that they do. Advice is what you (my clients) should do.  When providing advice, I take into account your situation, your business, your tolerance for some level of risk, your industry or market, the economic conditions, and many other factors.  One important common denominator is that all of this is related to you.

For one of the business owners that I worked with in the past, they asked for advice, but did not treat it as such.  Rather, they treated my response as if I was giving my opinion.  How did I know this?  They continued asking other people in the company what they would do, anyone from the head of sales to the receptionist.  Often this resulted in him doing whatever the last person that he spoke with told him (and yes, it was occasionally the person who answered the phones for the company — I do not recommend this leadership style).

Let me be clear, if you want my opinion, you are going to have to specifically ask me for it.  Why?  My opinion is not based on you, but rather based on me and things such as my risk tolerance.  It is most often distinctly different from my advice.

When you work with CFO On The Go, you need to understand the difference between asking for my advice and asking for my opinion. I am always willing to happily provide you with advice. This comes included in our many services. The importance of the distinction between my advice and my opinions are this: My opinions are just that: my opinions.  After working in and with small businesses for the past 35 years, I have a lot of opinions as you probably do. They are what I would do based on a specific set of circumstances. They are also not advice.

The advantages of good business advice are too numerous to list here, but we all know there are huge benefits to getting advice from others rather than thinking we have all the answers ourselves.  If you are looking for good business advice, please reach out to me at (737) 314-0060.  I promise you that I will not give you my opinion (unless you ask).

Selling or Lending? (August 4, 2024)

For convenience, most businesses provide payment terms to their customers.  This allows your customers to get instant access to your products and/or services while avoiding the delay of them paying you upfront.  Typically, businesses allow a customer to pay an invoice 15 or 30 or 60 days after delivery (you will often see this represented as payment terms of “net 15”, “net 30”, “net 60”).  What most business owners do not realize is that when they provide payment terms to their customers, they become a bank to their customers whereby they finance purchases and they lend this money to their customers for FREE!  This is something no bank would ever offer its borrowers.

Banks are very meticulous about collecting payments from their customers in a timely basis.  They send out payment reminders and have staff to make calls and collect money.  For most businesses, there is some level of auto-pilot of this function.  They do not have any regimen setup to actively collect payments.  If someone is late, they may call to ask about when payment should be expected.  “I need a week” is often an acceptable answer.

Some time ago, a client of mine (who shall remain nameless) was looking over their financial statements and asked me why, if they were profitable, they did not have more cash in the bank?  They were indeed making a profit, but failed to understand the interworking’s of their financial statements.  When they sold something on “terms”, they invoiced their customer which increased their revenue and increased their accounts receivable (the amounts owed to the business).  When a customer paid them, they reduced their accounts receivable and increased the cash in their bank (they deposited the payment they received).  For the business in question, they had been increasing revenue as they made sales, but a lot of customers were not paying their bills so their accounts receivable was also increasing.  This is why they were profitable on paper but did not have more cash in their bank account.

Accounts Receivable sits in the top section of the Balance Sheet under Assets, which is often overlooked by most business owners.  It represents the amount of “lending” you are providing to your customer base.  The best practice is to review this number at least monthly, if not weekly, and look at it comparatively.  You should be curious as to whether this number is increasing month to month and, if so, why is that the case?  If your business is growing, a reasonable amount of increase is the be expected.  The monthly increase of Accounts Receivable is one of the items you should be reviewing in order to properly manage your business.  By doing this, you will ensure that you are staying in your chosen industry and not accidentally going into the banking business.