How to Read & Analyze Your Ecommerce Income Statement

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All right, so let's dive into discussion about your financial statements. Now as an accountant I understand the value of financial statements and I'm comfortable reading them. But as a business owner I really, really understand the value of the financial statements in helping inform me as a business owner into what's going well, what's not going well, where I'm making money, where I'm losing money.

Hopefully if you're watching this video you also watched our introductory video about financial statements in general. My purpose in that video was to help you really understand and become fully committed to this journey of learning to read your financial statements, because I really talk about how it's one of the most valuable tools you have available to you as a business owner.

Now I personally think that the income statement is actually the easiest of all the financial statements to read and to understand, so it's a great place for you to dig in. And it's also a great place to start to understand how your business is doing day in and day out. So again, it's a really good place for you to begin your journey about financial statements in general.

1:25

So I think one of the first things you need to understand is some of the terminology that we're going to be using.

So first of all, a profit and loss in general is a summary of all of your revenue and expenses. So it's a summary of all the money that came into your business and all of the money that left your business in the day-to-day operations of your business. So it's a great place to understand where you're making money, where you're losing money, whether you're profitable or not. It's a pretty big deal if you're a business owner.

Also, I just want to make it clear, I'm going to be using the statements profit and loss, P&L, income statement interchangeably. Those are all the very same things. So if you ever hear those terms, they're all speaking about the very same thing.

Also, one of the things you need to understand is that a profit and loss covers a period of time. So if I say to you, how much money did you make last year, you'd be looking at your profit and loss over the course of the year. Or maybe you're evaluating the performance of your business over the course of a month. But whatever time frame you're interested in looking at, whether it be monthly, quarterly, yearly, a profit and loss covers a period of time.

And one of the reasons why that's important is because a balance sheet, which we'll talk about in another video, is a snapshot of a point in time. So one of the key differences between these two financial statements is this thing that income statement covers a period of time.

And last of all, it is one of the best places to see the story of the business during that time frame. So my goal today is to help you really break down what your income statement is showing you, and feel more comfortable reading the information, and show you some really great ways that you can manipulate the data on your profit and loss to help give you a better idea of what's going on.

3:04 The five parts of the income statement

So let's start by talking about the parts of the income statement, and then we're actually going to go into QuickBooks to show you how it all works, where to find it, how to run it, how to manipulate it.

So the first part of the income statement is the revenue, also known as the income. Some people call this just the cash. That's not a completely accurate statement, because income and cash are not the same thing, which we'll get into a lot more in depth when we talk about the cash flow statement in the videos in this series. But revenue is basically the money coming into the business.

Then directly underneath that we have the cost of goods sold, which is a very important expense category that I'm going to go into a little bit more detail in just a few moments. But the income minus the cost of goods sold gives you the gross profit margin, which is the most important metric for you to be watching as a product based business.

Also, everything below that would fall into what I consider basically expenses and overhead and all of that. So your gross profit margin minus all of your other expenses and overhead gives you your net income, which shows you at the end of the day whether or not your business actually made or lost money. A very, very important number to watch.

4:01 Finding it in QuickBooks

So let me pull up QuickBooks really quick and let's dive into discussion about this.

All right, so this is the QuickBooks interface. In order to find your profit and loss you're going to come over here to the left side where you have all these menus, and you're going to click on reports.

So when this report area opens up, you have this area at the top where you have your favorites. This is anything that you've starred. So right now I have this set up so that the profit and loss is starred, so it's one of those. But if it's not, then you just come down here to business overview and you would find it over here, right here it says profit and loss. Now I'm going to star it, now it'll show back up here.

So remember how I told you that this is over the course of a period of time. So right now it's defaulting to September 2020, but I'm going to pull this up and I'm going to tell it I want to see basically this year to date. Remember I told you that it shows over a period of time, so you have to indicate what period of time you want to look at. Make sure this is the period of time you're after.

5:13 COGS, overhead, and other income

So I'm actually going to simplify this first of all, to show you the key parts and pieces of this that we talked about just a moment ago, so you can see the way that this works before you get overwhelmed by looking at all the other numbers.

So first here at the top we have the income, we have all the money that came into the business. And then we have cost of goods sold. Now cost of goods sold I'm going to go into a little bit more detail right now.

So one of the reasons why we really recommend that you break out cost of goods sold separately is because it is one of the most important metrics that you watch. When I say most important metrics, this gross profit, which is income minus cost of goods sold, gives you gross profit. It's one of the most important things to watch, because you as a business owner, if you are not effectively selling your product for a good profit, then everything else that comes after that, you've already lost the battle. Before you ever get to overhead expenses, before you ever get to net income, you've already lost the battle if you're not even making margin at this gross profit level.

5:51

And while it seems pretty obvious, it can be really easy to actually lose sight of cost of goods sold and the gross profit if it's all buried inside of there. So if you're running a special deal at Christmas time or whatever and you significantly discount your product, or you had to rush order a bunch of product to get it there in time for a Christmas sale and your cost on the product went up, you may end up flopping this, so you actually lose the margin at that cost of goods sold level, so that you're not even selling your product for a profit and you didn't really realize it because it all got lost in the noise of the business.

So by breaking this out separately and keeping the cost of the goods you sell separate from all the rest of the expenses of your business, it lets you manage that level as a number one point of defense as a business owner, and it helps you keep an eye on that. And I'm going to show you in just a moment how to kind of watch the trends of how that happens.

6:43

So then under cost of goods sold we have all the expenses, and this is what I would consider all of the non-essential. And when I say non-essential I mean, if you're going to sell a product you have to have a product to sell. But in order to sell a product, you don't have to have rent on a warehouse, you don't have to market, you don't have to have employees, you don't have to have a cell phone. You can sell products without all those things, but you can't sell products without having a product to sell. So everything that falls under cost of goods sold kind of becomes like the overhead of the business.

And these are some examples of things that fall into overhead. So these are all considered like G&A expenses. Here it looks like they have this one set up to be general administrative, but you can also break it out according to like advertising, marketing expenses, sales expenses. You can break this out however you want. You can use subcategories to have this present any way you want it to.

So in this case you can see we have some subcategories to give us more information. So PPC, pay-per-click, I can see how we're actually running each of our individual pay-per-click campaigns, how much each of those are costing us individually. Or I can condense that all so I just see it as one thing.

But you can see these are some of the types of things that would be considered overhead expenses. Computer software, dues and subscriptions, insurance, professional fees, rent, telephone, website. You might see these kinds of expenses with any business, and any one of these expenses could disappear and you could still run a business. So for example, you don't have to travel to run a business. You do have to have products to run a business.

8:20

So then you have income minus cost of goods sold is gross profit, gross profit minus expenses gives you net operating income.

Now underneath that you have other income or other expenses. These are basically a place that you can kind of park money that's coming in, or expenses that are going out, that are non essential to the business. So for example, if I own a warehouse and I'm subleasing out parts of that warehouse to other companies, that's not core to the heart of my business, but it is still income that's coming in, and I don't necessarily want that income to get lost up in this top line and screw my margins of gross profit and stuff like that. So other income, other expenses is a place that you can park money that's coming in and out of the business that's not necessarily really part of the core of the business. So an example we have here is interest income, and then points credits from credit card uses and stuff like that.

So then you have net operating income plus or minus all of your other income and expenses gives you net income. This is what tells you whether or not as a business you've made money or you've lost money as a business.

9:53 Recording sales and profitability by channel

Now I'm going to actually break this out now bigger, because I want to show you some of the things that we consider best practices around setting up your books in a way that gives you the highest amount of visibility. Because how valuable your profit and loss is to you is really dependent on how effectively you set it up and how accurate you keep the data that's flowing through there.

So for example, you see here we have a lot of detail at this income level and we have a lot of detail at this cost of goods sold level. So this brings me back to something I want to show you guys real quick regarding best practices around setting up information for the income statement for an ecommerce business.

So I'm using Amazon as an example for this, but the same thing would be true for really any channel that you're selling on. So one of the most common mistakes we see people make when they're setting up their books for an ecommerce business is that they treat the deposits that are coming in from the payment processors as the sales amount. So they'll see this amount hit their bank account and they'll just say sales from Amazon $92,000, when in reality, and this is especially true of Amazon, if you are selling on Amazon and you're using FBA to sell on Amazon, as you know you have a lot of other charges and expenses that are associated with selling on Amazon.

10:43

So you have things like your FBA activity, your warehousing fees, the actual cost of selling on Amazon itself, promo rebates. You might have borrowed money through the Amazon lending channel, and all of that activity basically is netted out in this deposit that happens through Amazon.

And so if you're calling that one deposit sales, you're actually skewing a lot of other things. This is an actual example from one of our actual clients, where they had a deposit of 92,000 that came in from their bank account, but this is what it actually represented, was all of this activity. So sure, they had this net deposit amount come in of $92,000, but it actually represented $135,000 worth of sales, plus a whole lot of other stuff. Shipping income, sales tax collected, FBA inventory reimbursements, Amazon fees, chargebacks, shipping, all of this kind of stuff.

This is all information that is very relevant to a business owner in trying to make the decisions that they're trying to make. And if you just summarize it all in just one line item and you just call it income, you're missing a lot of detail.

11:46

One of the best practices that we recommend is that you record your sales from your channel by going directly to the channel to find out what really happened on the channel, and record that correctly in your books, and then reconcile the payment processors into what actually deposited into your bank accounts. And we have a lot of other videos on that on our channel, so make sure you look for those. But this is why, is because it gives you just a lot more detail.

12:12

And in fact, one more step farther that I would go, if you're selling on multiple channels, is I would then recommend you actually break all of that out according to the different channels that it's going through, so you can really see how each channel is performing.

So in this case you can see this sample company file that we're using is selling on several Amazon channels, eBay, Shopify. And because I have it broken out this way, I can see not only how my business is doing as a whole, but I can also see how every single one of these individual channels is performing.

So why is this valuable? Well, just looking at this I can see, for example, that this Amazon channel right here is actually losing money. While they might actually be making, you know, 8 grand in sales, by the time we actually store the products that's being used to fulfill this channel, the cost on the storage and the warehousing is so high that we're actually in a loss position for this channel overall.

So I may want to either cut that channel completely, I may want to increase my marketing spend on this channel to try to drive the sales up more, I might want to reduce the amount of inventory that I have sitting in the warehouse. But by breaking it out, instead of this channel getting lost in the noise and me just assuming everything's fine and not taking action, by having the data broken out really well I can see exactly. Because this is an Amazon channel, if I was just recording Amazon deposits as the sales, the amount that I was spending here in storage would have been buried here and I would not have really known what the problem was.

13:48

So you can see, by breaking out the activity that's important, by using class tracking to break out each of the individual channels, I'm able to really see what's going on with my business and I'm able to make really informed decisions.

So let me just show you guys how I did that. Basically I come over here and I just display the columns by classes. Now I'm not going to get into a lot of detail about that right now, because you can actually just, you know, Google class tracking inside QuickBooks and there's all kinds of videos and information that will show you how to do it. But this is what class tracking does for you, is it shows you a P&L by channel, which I consider really useful.

14:24 Trends and right sizing expenses

Another thing that I use on a very regular basis is right sizing costs by making everything a percentage of income. So let me show you what I mean by that. But first of all I want to show you some trending options that we have that I also find very useful.

So over here I'm going to just display the columns by month now instead. And now I can see how I'm doing as a business overall month after month. So I can see how my sales are doing. Looks like they're holding remarkably steady. Very, very steady sales. Gross profit margin though, kind of jumping all over the place. As far as how the overall business as a whole is doing, looks like I had a really killer month in March, looks like a really killer month in July. I'm consistently, steadily profitable, that's really great.

May and June were extremely close in their revenue, but they actually had a spread in their net income. So that's kind of interesting, because I can see here almost identical sales.

16:07

Let me break that out so you guys can see exactly what I'm talking about there, because this is the kind of stuff I want you to be able to evaluate in your books.

So I can see in the month of May, even though I had $25,000 more in sales than I did in June, June actually had a $70,000 higher net income.

Now I've used this line before and I think it's totally true. Egos chase revenues, but owners basically manage net income. So if I'm doing higher in sales but I'm dropping net income as a result, that's an unfortunate chain of events. That's not the direction I want to be heading as a business, and those are the kinds of things I want to be watching really closely on.

16:44

So if I want to know what happened here, why I was so much less profitable, one of the things that you can do is right size all the expenses by making them a percentage of income. So let me show you what that looks like really quick.

So I'm going to come here and I'm going to say, take this, make it a percentage of income, and run this report. So now what it's going to do is it's going to right size all the expenses by making them a percentage of the income in their month, so now I can watch the trends to see what happened.

So now that I've right sized these expenses and I can see them now as a percentage of revenue, I can glance down through this and I can see, where did the shifts happen, where did I spend more in one month than another as a percentage of sales. And that will help me understand where I lost ground. And then it may be that it's something that's clearly explainable, like maybe I hired a new consultant and had a pretty big investment that month, or maybe I did a big push on marketing spend. There could be a lot of reasons why, but this is one way that you can watch these trends over time to see how they're performing.

17:56

Remember how I told you the most important thing for you to watch as a product business, and actually I would argue any business but especially with a product business, is your gross profit margin.

So one of the things that can be kind of tricky when you're looking at trends is when you have percentages that are jumping all over the place like this. Like you have this 41, 22, 39, 84, 38. They're fairly close and it's kind of hard to see which direction things are trending, unless you do have big anomalies like this one.

One of the things you can do is you can look at a prior three month trailing average. So you can average these three and use that as a metric. So in August my trailing three month average was whatever the average is of these three, and that's a metric that you can kind of record and watch moving forward each month. And that's a way to kind of right size trending that you're trying to watch, when you're kind of getting lost in the month-to-month minutia of those things moving around.

18:52

So those are some recommendations we have. So another thing that our clients are always asking us about is their return on advertising. How are we doing on advertising, how's our advertising performing, are we getting a good return on it?

This is this line here, if you have this broken out. You know, this is total advertising and marketing. And I realize there's a little bit of a timing issue with this kind of stuff, because you run pay-per-click ads and then what sales are actually getting credit for that marketing spend. I realize this is not an exact science on this, but it kind of gives you an idea of how you're doing, and it definitely gives you an idea of how you're trending, because this is a percentage of income.

So you can say we spent 13% of income this month to get the sales that we did, this month it was 17%, 15%, 12%, 10%, 17%. Obviously the lower the better. And so in the month of August and in the month of April we did not get as good of an advertising return as we had in other months. And so this is a valuable thing to look at, and especially like I said, that three month trending over time. So if you just hired a new marketing agency and you're wondering how they're performing, in general, besides the specific marketing metrics you can watch like ROAS and CAC and stuff like that, this, which is your total advertising spend as a percentage of income, gives you a really good indication of which direction you're going as well.

20:14 KPIs and budgeting

So let's go back to the PowerPoint for just a minute and let's talk about some other things that we can be looking at.

So this is the difference between if you're breaking out your income just based on the deposit value, versus you're seeing it broken out in depth. This is kind of the difference between the ways that it would show up on your profit and loss. So you can see you get a much richer depth of information when you break it out correctly.

So your profit and loss, the real value in it is that it really allows you to answer these questions that just plague you as a business owner. Things like, should I invest more in inventory, should I hire a warehouse manager, can I pay myself more, should I change shipping companies. All of these decisions ultimately come back to having a significant financial piece as part of the questions you need to evaluate while you're making these decisions.

21:05

So a couple other ways that I recommend you use your profit and loss, like I talked about, looking at these trends over time. Breaking out your profit and loss over months, looking at how things are moving over time. Looking at your gross profit margin over time, because it is so important that you protect your margins at that level. Looking at net income over time, not making the unfortunate mistake of being one of those businesses that drive up revenue but lose net income as a result, because they're not managing their costs effectively.

And last of all, another tip that we talked about today was looking at expenses as a percentage of sales over time to see how you're really performing. Because if you ask me, you know, I'm spending a million dollars in marketing, is that too much? Well, I don't know. What percentage of sales is that? If you're a 10 billion a year business, a million a year in marketing seems pretty reasonable. But if you're only doing $3 million a year, then suddenly a million dollars sounds very expensive. So this is a really great tool for right sizing expenses and giving you a good benchmark for that.

22:06

Last of all, I just want to talk about a couple of ecommerce specific KPIs that I think are valuable things to look at.

Always COGS and gross profit margin. As far as the product that you're selling, you need to have a good margin on that, you need to be maintaining a good margin on that, you need to be protecting your margins on that and watching it closely.

Overhead as a percentage of sales, to make sure that you're managing the overhead well, and as your sales grow that you're achieving economies of scale that allow you to be more profitable.

Fulfillment cost as a percentage of sales, making sure you're not losing your shirt on fulfillment costs.

Advertising spend as a percentage of sales, making sure that you're getting good return on your advertising spend.

Net income as a percentage of sales, making sure that as your business grows you're becoming more and more profitable, it's actually putting money back into your pocket as a business owner.

And finally, evaluating all expenses as a percentage of sales helps you understand the directions you're trending, what expenses need to be managed more aggressively, where you're losing money as a business, where there's additional opportunity for efficiencies.

23:04

Last of all, budgeting and projections start with the profit and loss. So sometimes when we engage with customers and they're like, hey can you help us plan for this future Christmas season, understanding what our cash needs are going to be, if their profit and loss is garbage and they have done a poor job of setting this up and a poor job of tracking this data correctly, it's very hard to make budgeting or projection decisions on bad data. You know, the best indicator of future behavior is past behavior, and so starting with a good profit and loss that is historically accurate is the best place to start with budgeting and projections moving forward.

If you would like some more indicators on whether or not your income statement is set up effectively for your ecommerce business, download our white paper, 5 Signs of Bookkeeping Trouble with an Ecommerce Business. The link is right below.

If you're approaching a million dollars in sales with your ecommerce business and you could really use some help getting your accounting in good shape, reach out to us at our website, ledgergurus.com. We'd love to help you get your accounting in good shape and support you going forward.

If you liked this video, hit the like button, be sure to subscribe and share our video with all of your ecommerce friends. Comment below with any questions you have. Thanks, have a great day, and good luck with all your entrepreneurial endeavors.