Income Statement Breakdown (Part 3): Operating Expenses
This is part 3 of a 4 part series on the income statement. Taking the time to understand each part of your income statement will help you to save money and make more money in your business.
In the Revenues section of your income statement, you started with Gross Sales and ended with Net Sales. In the Cost of Goods Sold section of your income statement, you had the choice of either using the accrual method or the cash method to take the Net Sales number and end up with Gross Profit.
Now, we’re looking at operating expenses. Operating expenses, as the name implies, are the expenses associated with running your business. These expenses might include salaries, advertising, supplies, rent, insurance, utilities, and depreciation. These are added up and subtracted from the Gross Profit number we calculated in the last section of the income statement. The number we’ll end up here is sometimes called Net Profit and sometimes called “Income”.
Let’s keep building on the income statement of the fictional business we’ve been talking about, but we’ll use both the accrual example and the cash example so you can see how both work:
ACCRUAL EXAMPLE
OPERATING EXPENSES
Salaries: $300,000
Advertising: $50,000
Supplies: $10,000
Rent: $50,000
Insurance: $5,000
Utilities: $20,000
Depreciation: $5,000
Subtotal: $440,000
Subtract subtotal from Gross Profit: $665,000
Net Profit: $225,000
(This accrual example draws the Gross Profit number from the detailed example we gave last week where we calculated the opening inventory for the month and the closing inventory as well as the money the business spent on various raw materials and shipping.)
CASH EXAMPLE
OPERATING EXPENSES
Salaries: $300,000
Advertising: $50,000
Supplies: $10,000
Rent: $50,000
Insurance: $5,000
Utilities: $20,000
Depreciation: $5,000
Subtotal: $440,000
Subtract subtotal from Gross Profit: $330,000
Net Profit: $645,000
(We arrived at this number by taking the Net Sales number of $975,000 and subtracting only the money the business spent on wood, paint, nails, shipping, and warehousing – but NOT opening and closing inventory.)
This number gives us the Net Profit of the business. Many of the costs associated with doing business have been taken out of this number and what is left can be considered profit. You can use this list of operating expenses as a checklist each quarter or each year to review what you are spending and to find ways to reduce expenses. Simply slashing expenses may not give you the same result; finding ways to reduce expenses without impacting the result is what you are aiming for. For example, can you still do the same job if you reduced supplies? What about if you negotiated a longer-term lease for a lower per-month rent? Can you cut utilities by turning down the heat in the office overnight?
We’ve gone from Gross sales to Net Profit… but we’re not done with the income statement yet! Check back next week for the last step in this series.