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Business Plan Financials in Plain English – The Income Statement – Part 13 of the 2009 Business Plan Series

February 26, 2009 :: Steve Fisher

The previous 12 parts of the business plan focused on the written sections and as we reach the back of the plan the critically important financial statement section comes into view. However, the view doesn’t look so clear because to many it looks like a dense cloud of numbers and characters that only a “quant-jock” could understand.

Granted, many who will review the financial statements are spreadsheet junkies or “quant-jocks” who live and breath numbers. In fact, if they get their hands on a business plan, they jump to the end of the plan to read this part just like those who read the end of a mystery to find out who did it and the outcome of the story.

So this is why someone like myself who has started a few business, has an accounting degree he never used and loves to write might be unique qualified to bring you Business Plan Financials in Plain English. So what is the best one to start with? Easy. The one that shows you how much money a company earned and all the money a company spent during a certain time frame – The Income Statement.

Plain English Definition of the Income Statement

A company’s income statement is a record of the money it made and spent for a given time frame, usually a quarter or year. It shows all of the money a company made (revenues) and all of the money a company spent (expenses) during this time frame. It also accounts for the effects of some basic accounting principles such as depreciation.

Plain English Components of the Income Statement

To keep on the plain english format we have set, we need to tread carefully into the definitions of terms you see on the income statement. We will do our best and not go anywhere near equations. If you would like to geek out and dive a little deeper, I would invite you to go here. With that disclaimer said, let’s dive into the kiddie side of the financial statement pool.

Gross profit on sales (also called gross margin) is the difference between all the revenue the company earns and the sales of its products minus the cost of what it took to produce the. They also call this “top line revenues”.

Operating income is how much a company makes from its core business after it has deducted its cost of goods sold and its general operating expenses. Operating income does not include interest expenses or income generated outside the normal activities of the company (e.g. investment income).

Earnings before interest and taxes (EBIT) is a term that investors love to ask you because it includes the combination of operating and non-operating income but excludes interest expenses and income tax expenses.

Net earnings or net income is basically the bottom line. If it is positive, you are “in the black for the year. If it is negative, you are “in the red”. This is the profit your company makes after all of its income and all of its expenses are taken into consideration. Positive net income is usually the typical benchmark of success. You might also be asking how a company can have negative net income and still be considered ok. This has to do with cash flow, assets and its growth projections that will be explained in other posts.

Plain English Explanation of Why People Need to Review the Income Statement

The income statement is important for investors because it’s the basic measuring stick of profitability. A company with little or no income has little or no money to pass on to its investors in the form of dividends. You can identify where the company spends much of its income and compare that to similar companies. If the company continually makes substantial profits, it indicates to bondholders that it is a stable company. If a company continues to record losses for a sustained period, it could go bankrupt. In such a case, both bond and stock investors could lose some or all of their investment. On the other hand, a company that realizes large profits will have more money to pass on to its investors.

NEXT TIME: The Balance Sheet in Plain English

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