Tag Archives: P&L statement

Startups: When Will You Be Profitable?

When Profitable PhotoAs the founder of a startup company, you should be able to determine when you will be profitable. But how can you do that before you even start?

The answer is you need to make some assumptions. In fact, you need to make many assumptions. It is very important to record all these assumptions because during the first few months of your company, you will have to create experiments that validate whether or not these assumptions are true.

So the first step in determining when you will be profitable is recording all your assumptions. See my earlier blog, What Assumptions Does an Entrepreneur Make, for a sample list of such assumptions.

The second step is to create a pro forma income statement based on those assumptions. If you are not familiar with what an income statement is, see my earlier blog, Seven Things an Income Statement Tells You.

The third and last step is to examine the row of the income statement labeled EBITDA (Earnings before Interest, Tax, Depreciation, and Amortization) from left to right looking for the first entry that is positive. If that entry is in the second column, then the answer is you will be profitable in the second year of your business. If it is in the third column, then the third year, and so on.

Most startups are not profitable in their first year. This is because of high starting expenses, as well as the inevitable high cost of goods sold associated with low volume sales. So, if your assumptions show you as profitable in year #1, you may want to rethink your assumptions. And if you are seeking investment capital, I can assure you that investors will look more favorably upon your enterprise if you show realistic numbers, not overly optimistic ones.

 

ABOUT THE AUTHOR:

Alan DavisDr. Al Davis has published 100+ articles in journals, conferences and trade press, and lectured 2,000+ times in 28 countries. He is the author of 6 books, including the latest, Will Your New Start Up Make Money? He is co-founder and CEO of Offtoa, Inc., an internet company that assists entrepreneurs in crafting their business strategies to optimize financial return for themselves and their investors. Formerly, he was founding member of the board of directors of Requisite, Inc., acquired by Rational Software Corporation in 1997, and subsequently acquired by IBM in 2003; co-founder, chairman and CEO of Omni-Vista, Inc.; and vice president at BTG, Inc., a Virginia-based company that went public in 1995, acquired by Titan in 2001, and subsequently acquired by L-3 Communications in 2003.
Photograph of CoverIf you’d like to learn if your great business idea will make money, take a look at Will Your New Start Up Make Money? If you’d like to verify that your great business idea makes financial sense (and also as a tool to transform your assumptions into financial statements), sign up for www.offtoa.com.

How to read an income statement for a startup

How to read an income statement

When you plan a start-up company, you will need to create pro forma financial statements, including the income statement, cash flow statement and balance sheet. A pro forma income statement (also called a profit and loss statement, or P&L statement) is the tool used by businesspeople to determine if a company is profitable (or not) over a period of time. Specifically, it shows what revenues, cost of goods sold, expenses, and profits of a company would be, based on a set of given assumptions. The figure below shows an example. It is a pro forma income statement for the first 5 years of a start-up. Like every income statement, it is organized into 4 horizontal sections:

Revenues

This section shows all primary revenues sources. Companies categorize revenues in this section in a variety of ways, but two common ways of organizing them are (a) by product (or family of pro­ducts), and (b) by market. This enables readers to understand what the reve­nues sources are. The example shown in the figure has revenues organized by product.

Cost of goods sold (aka COGS)

This section shows costs associated with actually producing products that were responsible for the revenues shown in the previous section. This includes the cost of raw materials, shipping the products to customers, and labor costs associated with manu­facturing and maintaining inventory (and labor costs associated with delivering services to the customer, if that is standard practice within the selected industry). Like revenues, COGS are also often organized by product or by market, or sometimes they appear as just one number. The example shown in the figure has COGS organized by product.

Just below this section, COGS are subtracted from revenues to calculate gross profit. It is used to determine how efficiently your company produces its products. It is most mean­ing­ful when compared to other companies in your industry.

Expenses

This section lists all expenses incurred by the company during the indicated period of time, categorized by corporate division: General and Administration, Manufacturing and Production, Marketing and Sales, and Research and Development.

Summary lines on income statement

At the bottom of the income statement are a series of totals and summaries that help you understand the company. They include:

  • EBITDA. Literally, earnings before interest, (income) tax, depre­ciation, and amortization. Calculated by subtracting expenses from gross profit. This is the value that most investors look at when they are trying to determine how well the company is predicted to do. Also, for most industries, it will be one of the primary determinants for valuing the company in the case of an acquisition or public offering.
  • Depreciation. This is calculated from the depreciation schedules and useful lives of major purchases (i.e., fixed assets) you have made. Specifically, it is the sum of all depreciations applied during the period of this income statement (for major purchases made prior to or during this period).
  • EBIT. Earnings before interest and (income) tax. Calculated by subtracting depreciation from EBITDA.
  • Interest. Any interest earned by the company from its assets, or any interest paid by the company.
  • Provision for income taxes. This is calculated by multiplying your income tax rate by EBIT. However, if you had previous years of accumulated losses, they will be subtracted from the current year’s EBIT first. Notice, for example, in the company shown in the figure, no income tax is shown for fiscal year 3, even though it was profitable; losses from its earlier years were subtracted from its profits of year 3.
  • EAT. Earnings after tax. Calculated by subtracting interest and income tax from EBIT.
  • Cum net. Cumulative net earnings. The sum of all EATs for all periods up to and including the current period.

Pro Forma Income Statement for NewCo, Inc.

Fiscal Year 1

Fiscal Year 2

Fiscal Year 3

Fiscal Year 4

Fiscal Year 5

Revenues

   Super New Product

$0

$49,500

$180,000

$540,000

$1,320,000

   Training Course

9,996

33,000

43,200

54,600

66,000

   SaaS Software

0

600,000

1,000,008

1,599,996

2,000,004

   Total Revenue

9,996

682,500

1,223,208

2,194,596

3,386,004

 

 

 

 

 

 

Cost of Goods Sold

 

 

 

 

 

   Super New Product

0

31,356

114,948

341,400

834,540

   Training Course

828

2,496

3,000

3,492

3,996

   SaaS Software

0

0

0

0

0

   Total Cost of Goods Sold

828

33,852

117,948

344,892

838,536

Gross Profit

9,168

648,648

1,105,260

1,849,704

2,547,468

 

 

 

 

 

 

Expenses

 

 

 

 

 

   General & Administrative

249,420

260,904

344,004

362,736

383,940

   Manufacturing & Production

63,504

66,672

140,028

147,024

154,368

   Marketing & Sales

24,996

45,396

52,800

60,204

67,596

   Research & Development

381,000

533,400

280,056

294,036

308,736

   Total Expenses

718,920

906,372

816,888

864,000

914,640

EBITDA

(709,752)

(257,724)

288,372

985,704

1,632,828

   Depreciation

8,328

8,328

13,332

26,670

35,004

EBIT

(718,080)

(266,052)

275,040

959,034

1,597,824

   Interest

0

0

0

0

0

   Provision for Income Taxes

0

0

0

62,486

399,456

Earnings After Tax (EAT)

($718,080)

($266,052)

$275,040

$896,548

$1,198,368

 

 

 

 

 

 

             Cum Net

($718,080)

($984,132)

($709,092)

$187,456

$1,385,824

The above is extracted from my latest book, Will Your New Start Up Make Money? Buy your copy in Kindle at http://www.amazon.com/Will-Your-Start-Make-Money-ebook/dp/B00JOOZQNE or paperback format http://www.amazon.com/Will-Your-Start-Make-Money/dp/0996028307