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Okay, welcome to another edition of ask spurl CPA. Today we’re talking about organizing your income statement and I’m here with Tyson from our face and thanks for being here today on the show and they’ll taste it and tell us a little bit the boat, your, your journey to the from here. And how long have you been here Edmonton CPA?
Yeah, I’ve been there for two years now. I took my four year bachelor of business administration emphasis in accounting at nate and I’m currently pursuing my CPA designation now. Huh?
Okay. So um, you know, why organizing your income statement is important is you know 80 percent of small business owners would score less than 70 percent on basic business financial literacy tests, which is a little bit scary because there’s a lot riding on these small businesses and knowing that they’re going to get significant components wrong. So what we’re focusing on today is that part of the, part of the financial statements, the income statement and you know, the story that we have is we get entrepreneurs who come in and they have these long income statements and you can’t fit them on one page or the three and four pages long and the, the organization is often, and now they’ve Edmonton CPA come to us because they’ve probably made bad choices, you know, they’ve run out of cash. Um, you know, they, they, they bought a piece of equipment that’s not working out for them, you know, they hired staff and they can’t afford to pay them and a lot of it has to do with the organization and that income statement on having something that’s usable and user friendly.
So these entrepreneurs are coming in and you’re seeing, they come in with a disorganized or too long financial statements. What are the questions you think that they should be asking Tyson? Oh, the first one would be, what are the main four, one of the main four sections of an income statement. So the, the sections of the income statement that you started the top, you know, being revenue, so that’s simply the, the gross amounts that you’re bringing into the business, know the, the, the, the gross invoices that you’re billing out to your customers. Then followed by the cost of sales. So the costs of sales with the cost of that are directly related to providing those services. So Edmonton CPA the staff who are working directly on the projects, I’m the supplies or materials that are bought and then sold to the client. So the things that, that, you know very directly with every sale, there’s another direct input of costs, a following those direct costs.
Now we’re getting into the general expenses of the business. So these are expenses that you know, the business is responsible for but they don’t necessarily very directly with each sale as the direct cost too. So, you know, the, the main ones in most businesses on the general expenses are, you know, the rent, the administrative staff, the amortization of the equipment in the buildings that they have, the business as well as, you know, the office supplies and the utilities which generally are too variable that the, uh, the doesn’t vary with every new, every new contract that they take on or every new project that they take on. So, um, and then the last thing is the other income or other expenses, Edmonton CPA, and these are the items that don’t necessarily do with the day to day operations of the business, you know, things like, uh, the corporate income tax, the salaries paid to the business owners.
Um, so those are the starting from the top, we have revenue, we have cost to sales, we have general expenses and then we have other income than expenses. And those are the four main sections that people should be organizing their income statement and a why is it a good idea to organize your income statement and numerically descending order? Yeah, great question. So, um, you know, some people organize it alphabetically and some people, I don’t know, they have some sort of artistic interpretation of why they’ve organized and I’m not sure, uh, but numerically descending is going to keep you focused. So what I’d like to do with the exercise I’d like to do with a lot of business owners is you have this income statement and you literally draw a line in the middle. Once you have this organized in numerically descending order and now you look at, Edmonton CPA you’re going to have all the big numbers at the top.
You’re going to have your revenue, you’re going to have your cost of sales. You’re going to have generally here the rent that you’re paying, the administrative staff that you’re paying. And you know, maybe you have the supplies account, but at the bottom you’re going to have things like income interest in bank charges. You don’t, maybe the cell phone bill and business owners tend to be very fixated on those little items. And they can spend a lot of time on those little items that aren’t really gonna move the needle for it that much. You know, we only have 168 hours in the week. The time that we need to spend needs to be focused on those other items. What’s the direction? What’s the gross margin on every project? If you’re a construction guy, you know, what is the gross margin on every patient you see? If you’re a medical practitioner and you’ll failing that, Edmonton CPA then what are the costs of those administrative staff that you have?
What are you paying for rent? These are the items that are really going to make a difference in your business in terms of what the net profit that’s left over. We don’t want to get sucked in, you know, into the weeds and you know, to be spending, you know, eight hours trying to make our interest in bank charges from $35 a month for $30 a month. Because know that’s how we lose money. So should your income statement be more than one page long know small businesses, your income statement needs to be on page. You need to be able to use this thing to make business decisions quickly. Uh, and you need to refer to it if every time you have to make a business decision, you have to look through multiple pages, Edmonton CPA we should have the ability to drill through, but we need to be able to summarize in one page so we can make decisions, you know, intuitively on good numbers.
And if you could summarize your income statement onto one page, um, you know, that’s, that’s, that’s the game plan for small businesses. If it’s longer than that, it’s usually overly complex and it’s gonna result on making decisions on bad information rather than. Sometimes people think will make better decisions. I’m more detailed. They tend to just lose track of the big picture. What happens to your classification variance analysis when your chart of accounts gets too big? So let’s, let’s take office supplies for example. You know, we would just rank it, we have office supplies and most small businesses and they’re going to, a lot of small businesses are going to spend, you know, no more than 5,000, Edmonton CPA maybe no more than 10,000, maybe even no more than 20,000, but it’s not going to be that huge number. It’s not going to be what you’re spending on salaries and not going to be what you’re spending on rent.
Let’s say that business owner thinks that I, I think I’m gonna, I’m gonna, make this more sophisticated and I’m going to have one for ink toner and going to have another one for paper and pens and I’m going to have another one for general office supplies and they think that they’re doing themselves a service and what tends to happen is the more complex that you get in those classifications, the more errors that you make. So your classification starts to become ambiguous. I put it in general office supplies. Do I put it Edmonton CPA if I bought a stapler, is it in paper and pens or is it in this one? And they tend to start actually being rather ambiguous and their classifications and when you start to look back on the historical performance month to month or year to year and see how you’re doing year over year, you actually lose track of it and you just classified in a different way rather than you’ve actually changed your spending habits in any meaningful a matter really.
Great. Is it okay to use sub accounts or items? If you need more detail, that’s the move. You know, you don’t want to have so many primary accounts that this thing is going to be two, three, four pages long. If you absolutely do need more detail, you can use sub accounts where you embed or multiple keeping software. They have items in there. So if you actually ever do want to track it by supplier or if you have a specific item, you can run a report later on that item if you want to get deeper into the analysis, Edmonton CPA but it doesn’t cloud the big picture income statement that you can use to make, um, you know, real high level decisions quickly and efficiently and, and regularly. Uh, why do you recommend no more than three revenue accounts? So you want to be able to wind up your revenue counseling to no more than three revenue accounts because that’s where the planning happens.
Let’s say you have a save a restaurant or you know, you have 50 different things on your menu or your doctor and you have hundreds of things that you can bill for if you’re a construction guy and sometimes you’d come up and fix a door and sometimes you build someone a new house. There’s a huge variance. But ultimately you can boil these things down into no more than one. You know, if you’re the restaurant, you have, you know, what is the average, what’s the average bill size every time someone walks through the door, Edmonton CPA, you know, every person that walks in the door orders average of this off the menu. You know, if you’re the doctor, every person, every patient who comes to the door, you build them. This, if you’re a construction guy, your average project is this, that lets you plan. If try to plan how many orders of onion rings you’re going to sell in a small business, we’re not Mcdonald’s, we don’t have enough data in order to run that.
So you’re actually going to be off in your projections. If you can boil it down to an average in a small business, you’re going to have enough data to actually make reliable projection. So it’s all about getting to an average item size, an average ticket size and average widget, if you will. Edmonton CPA, and then you can do reliable projections on that average. Uh, what sort of things should you be putting in your direct cost of sales section? Yeah, so touch on that again, the direct costs of sales. These are the things that vary, you know, with every, you know, every sale if you will. So, you know, we’ll go back to the, the construction guys. So in the construction guy, every time he does a new project, he has to buy more materials, he has to pay subcontractors and maybe has self perform work from the guys who are doing the projects on the work.
So these aren’t the people in the office, either the people out in the sites doing it and you go to the medical practitioner and these are the associate doctors, you know, for every, uh, in a dental clinic for every, you know, $100 that’s built that got to pay out $60 to the associate dentist. So that’s a direct cost. Every time there’s a sale, there’s an associated cost with it. Right? Um, so, so things that very directly, um, you know, that there’s a cost incurred that directly correlates to every sale in most businesses. What are the most significant general expenses? Yeah, the significant general expenses. They, the key culprits, if you will, uh, it’s generally going to be the cost of your administrative staff. Uh, that’s going to be pretty significant. You know, you have one or two salaries, three, four salaries. Even in most small business, Edmonton CPA that’s a big line items.
So the cost of those administrative salaries is, is up there. A rent a is usually up there. You’d be paypal or paying a significant portion of revenue on rent. Um, and usually amortization of the property, plant and equipment. Those are probably the three most common that are likely to be at the top of your income statement that deserve your time and attention, where if you can make an improvement in one of those, you’re really going to make significant differences in your profitability as opposed to spending time on how much you spend on. Can you get a bundle of paper for $20 or $18? It’s not going to make a difference. Material difference in the income at the end. Why should you put, why should you not put salaries to the owners of their families? Indirect cost of sales or general expenses? Yeah, so if you think about the organization of the income statement, Edmonton CPA you’re going to have the revenue.
You know the direct costs of sales, you’re going to have the general expenses rate under the general expenses. You’re going to have a line that’s called income from operations. If you haven’t put the owner salary and the general expenses with the direct costs of sales, that income from operations is going to be the best number to tell you. What do you make in your business before the owners and their family? It gets paid and that’s the number one tax id number that we need. You know, that’s what’s, Edmonton CPA that’s what’s available. Often the owner’s salary is more dividends, more driven lifestyle choices or tax strategy rather than how much it would actually cost them. So it really gives you that nice number of how is my business doing before I pay myself, what do I have available to pay myself? So that’s the value in doing that, right?
What sort of items go into the other income and expense category? So the sort of items that go in the other expense category are now you do have to account for those salaries to owners. And it’s really nice whenever you’re applying for financing. What’s the first thing if you don’t organize your statement this way, you’re immediately talking to the banker and they want to say, well, how much are the owners getting paid in that salary line item? So you’re going to put the salaries of the owners and their dependents, the other family members who are being paid under the business. Um, that’s going to be a standalone item in there and it’s really nice the organized for financing or planning purposes. Also the corporate tax is also going to be in that other income and expense a section as well as generally there’s going to be some investment income, you know, Edmonton CPA if the business itself is saving, which is normally a prudent tax strategy, you’re going to have, you know, the investment income.
So you know, if you’re a, you know, I go back to the doctor or a restaurant owner or construction guy a, if you buy shares in apple in your corporation that doesn’t really relate to your business, but we need to account for it, but we don’t want it clouding that income from operations number. So it’s the income and expenses that aren’t directly related to the day to day business. Isn’t that income as important as income for brokerage? Although net income is important Edmonton CPA, it’s probably not as important as income from operations. And the reason is is because often net income is tax driven. You know, the business owner might have made $100,000, but let’s say they took out $150,000 because they bought a new house this year and we declared extra salary. That doesn’t mean their business did any worse this year. Lots of times. It just means they took more money out of the business.
Um, which often revolves around life events rather than how well the business is doing. The business might have been doing better than last year, but if you look at that net income item, you’re not taking into consideration those items that don’t, you know, very with the business, how much were the owners paid, Edmonton CPA, you know, did my investments do well or not? You know, that doesn’t have any effect on the main business. It has to be accounted for, but you want to be able to isolate the difference from those. So I think that’s, uh, that’s all we have for today. Thanks again for watching. If you have any, uh, comments that you’d like to have answered, no, please put them below. We’ll try to address them in a future video. Next. Very much.
