Next Level Pros - #111: Income Statement Explained and How to Use it to Grow

Starting point is 00:00:00 Not understanding the financials of your business could be costing you millions. In this episode of the Founder Podcast, we're going to help you understand an income statement and build a break-even analysis. When it comes to building out a roadmap for your business, it's important to know where you're starting so that way you can know where you want to go. And we're going to teach you all of this on this episode of the Founder Podcast. All right. So we are going to jump into the income statement and really be able to understand, is my business scalable? How are the different functions, breakeven analysis, all that good stuff. So jump on over to the iPad with me. We over here have just a basic income statement that goes over what really any business owner has to take a look at. Sales. This is the amount of revenue that comes into the

Starting point is 00:00:54 business. This is after taxes and everything. I like to look at it. There's a traditional way to look at it with gap accounting principles. And then there's the business owner way of looking at it. For me, when I'm looking at sales, this $200,000 number, I'm looking at everything after sales tax. I'm looking at everything after dealer fee, if I'm paying a finance fee or whatnot, like dollars that are deposited into my bank account that allow me to go and create expenditures from. So that's the number that I need to understand in my business. Once again, there's ways to do things in accounting and then there's ways for you as a business owner to really understand that. You need to understand how many dollars are coming in, not how many you sold or hope to get or whatnot, but dollars in the

Starting point is 00:01:41 door for work that you have completed. That is this number that you want to be looking at. Then we have what's called the cost of goods sold. So understanding cost of goods sold, this is your inventory. This is your direct labor. So, for example, if you run a roofing business, this would be the cost of shingles. This would be the cost of fuel. This would be the cost of everything that's. This would be the cost of fuel. This would be the cost of everything that's associated with getting it on a customer's roof, where if you did not have it,

Starting point is 00:02:12 then you would not be expensing it, right? You wouldn't be spending money on materials. You wouldn't be spending money on direct labor. And so that is ultimately your cost of goods sold, which leads you to your gross profit from where you can determine what your gross margin is. In this particular example, they have a $90,000 gross profit from $200,000 in sales. This means that there is a 45% gross margin. Okay, GM. Gross margin is the amount of money, if you did not have any fixed costs that you would keep or once you have your fixed costs covered the amount of money that you would keep for every dollar sold so essentially once you're breaking even in this business every dollar collected

Starting point is 00:02:59 would mean 45 cents to the bottom line and that's why it's so important to run break-even analysis, which we will talk about here in the next video. But as you understand, so first of all, you want to understand what are my variable costs. Variable costs means that you only pay them based on the amount of revenue that you sell, right? So once again, this goes to inventory and everything that goes into all your COGS and then understanding what your gross margin is, which we just talked about. And then the other aspect that I like to factor in that actually goes below the line in a typical income statement. So a typical income statement has the cost of goods sold and the gross profit above, and then the operating expenses, which on for these particular things, you have advertising costs and payroll and commission. I like to figure out what my cost

Starting point is 00:03:55 of acquisition is or your CAC. And I actually like to move that above the line. The reason why I like to move that above the line is because typically this is directly correlated with the amount of revenue that you are doing, especially as we're going to talk about later in the offer section. When you are running ads online or whatnot, you can directly correlate and add to a customer. It's direct marketing. I know if I spend a dollar, I'm going to get $3 back. So I want to understand how that is tied in. And I'm going to usually look at that as a variable expense. So in this particular situation, I would move it above the line. And I would say that I actually have $150,000 in variable expenses and $50,000 in gross profit. And so my gross profit margin would be 25%.

Starting point is 00:04:56 That means this would be the case if I double my payroll and commission and advertising costs. So if I move this up to $10,000 and move this up to $75,000 or $70,000, so a total of $80,000, then I would be able to double this number. So this would go up to $400,000. If it's directly correlated, and this is what we're going to teach you is to make direct correlations with how much you spend in marketing and sales so that you can scale up your business. Then you know for every dollar that you spend in this particular example, you're going to get $5 in revenue. For every dollars in sales commission and marketing, you're going to get five dollars in revenue, which ultimately produces a gross profit margin of 25 percent. Once again, this is not how the accountants typically do it, but this is how you need to look at it as a business owner. And so and then really understanding what your cost of acquisition. Later, we're going

Starting point is 00:06:01 to talk about we're going to talk about some of the fundamentals of your unit economics. But let's break this down. Let's say the unit economics for this particular business, that they did every, the unit economics, the average cart value, ACV, or the average ticket in their service was $2,000. That would mean that they do 100 sales or 100 installs a month. Because 100 times 2,000. Am I doing this right? Yes, would be $200,000. So in this particular example, if they got 100 sales through $40,000 of payroll and commission and advertising expense, this would mean that $400 is their cost of acquisition. CAC for every four hundred dollars spent, they get one customer in the door that is paying them an average of two thousand dollars. Now,

Starting point is 00:07:14 I had to extrapolate this, right? This this particular financial doesn't tell me exactly what their average cart value is or their average ticket value. But this is absolutely vital for your business. You need to know what your average customer is paying. So whether you're doing a roof or whether you're doing whatever it is so that you know that my marketing dollars and my sales dollars are getting more than what we are spending. In this particular example, we do know that is the case, right? So essentially for every $1, this is what we call a ROAS, a return on ad spend. So in this particular situation, we'd just be looking at marketing. So this would be $5,000. That would be 2040. This would be a 40 to one ROAS, a return on ad spend. So for every dollar I spend in marketing,

Starting point is 00:08:17 it's going to equal $40 in revenue. Okay. This would be a remarkable ROAS. And this is the kind of ROAS that I look for in my home service companies. And so for every dollar I spend there, I'm going to get a return. Now we can analyze the payroll and commission. In this particular instance, they are paying 17.5% of their revenue towards payroll and commission for selling. It's a little on the high end. Typically, what I like to target is sub 10. 11 is stretching a little bit, but 10% is where you want to be really making it in there. So then the question is, is this scalable? And the answer is absolutely, because I know for every dollar that I spend in marketing, I'm going to get $40 in return,

Starting point is 00:09:11 as long as it's directly correlated. And we're going to teach you how to directly correlate it. And that at the end of the day, when you factor in the commission and payroll and everything, you are still at a 25%, right? So that means if I spend more, I'm going to be able to scale it. And as long as I stay on top of those things and I control, this is the reason why you have a controller. This is your job as the CEO and founder to really monitor and make sure that none of these expenses go out of line. And so as you increase revenue, that expenses either increase at the same as a certain percentage of that revenue, or they actually decrease where you get economies of scale. That's the ultimate goal. If you can get economies of scale where expenses as a percent actually go down. So like, for

Starting point is 00:10:01 example, for every $100, if you had $25 in expense, so that would be 25%. If you went to $300, you would hope that it was $75 or less. If that is the case, then you have a scalable business and you're properly managing this. And so we're going to jump into a little bit more detail. Now, what I want you to take right now is if you have access to your income statement, I want you to go and spend the next five to 10 minutes, better understand it. What do my sales look like? What is my cost of goods? What is my gross profit and my gross profit margin, my gross margin. If I use this idea that advertising and commission and sales actually go above the line, do I still have a gross profit margin? Does this make my

Starting point is 00:10:56 business actually scalable? Can we cover our fixed cost? In the next little video, we're going to dive more in detail into this. You guys have seen it in all of our other content, but we are hosting a workshop on June 25th. We're going to teach you how to build a five-year roadmap for your business. On June 25th, we're hosting a five-year vision and growth workshop. In this workshop, we're going to be teaching you guys how to build a roadmap from A to Z for the next five years for your business. A lot of business owners, they are trying to solve everything in their business. And unfortunately, a lot of the times that forces you to not take any action at all.

Starting point is 00:11:36 Clarity creates action. If you don't have a clear plan to understand where your business could take you over the next five years, you're not going to be able to even know what steps it's going to take to hit your goals. On June 25th, here at our headquarters in Pasco, Washington, we're going to be teaching other business owners the five-year growth model that we use and implemented to start our business in a garage and selling it for nine figures in just five years. If you click the link in the description, it's going to take you to our page where we show you all the information, the things that we're going to teach you at this workshop. If you can't make the workshop in person, that's totally fine. You can also secure

Starting point is 00:12:15 your seat virtually by joining us virtually for over half off. Click the link in the description so you can secure your seat now because we're keeping it to limited seats so we can give every single person intimate attention. So go ahead and click the link below and we'll see you on June 25th. All right. So hopefully you have taken a few moments, pulled out your income statement and better affiliated yourself with it and where you're at. You know, the thing I always like to say is don't lie to yourself. So many business owners, we are up in the night. We think like, oh, these are what my numbers are, or we just love to live in the land of self-deception where we deceive ourselves. The best thing you can do is have a reality check and do it on a regular basis. Understand

Starting point is 00:13:01 your financials, understand them inside and out. Where are you winning? Where are you losing? What can you cut? What can you increase? Those are those different type of things. So let's dive a little bit further into the income statement. So we just talked about understanding kind of you're above the line. And then we are now talking about fixed costs and below the line. So one of the things that we see on here is they've combined their payroll and commission. When we're talking about cost of acquisition, you want to separate your fixed cost payroll, your administrative, and those type of things. And it looks like in this particular example, they haven't separated that. So separate your commissions and sales, and then your administrative, because your administrative is going to get paid regardless.

Starting point is 00:13:47 And hopefully you've structured your sales where they are going to be more incentivized by commissions and performance. And so there's going to be a more of a variable aspect to that. But understanding what your payroll is, the other things that obviously are fixed, you got rent, you got office equipment, you got utilities. You're going to pay these regardless of what happens every single month. This is your nut that you have to cover. In this particular example, it looks like $7,500, $8,200 in rent, utilities, office equipment. And then there's an aspect of payroll. Let's just say it's $20,000. Let's call it $15,000. Okay. So if it's $15,000, we're going to say 20 goes up to commissions. And then you still have that $5,000 in advertising. So we're going to use this to be able to determine our breakeven analysis.

Starting point is 00:14:48 Once again, I want to know my cost of acquisition as directly tied to the acquisition of these actual accounts. So in this, I would say, you know, going back to our previous example, we were saying that each account is worth $2,000. There's $25,000 associated with getting $200 each. There was 100 total installs. And this, going back, we're going to add $25,000 divided by 100. $250 is my cost of acquisition. But more importantly, let's look at what our gross margin is under this example. So if you have $25,000, we're going to subtract that from my gross profit. That's going to get me to $70,000, $65,000, $65,000 in gross profit. Once again, these aren't normal accounting rules. We're moving it

Starting point is 00:15:47 up to be able to better understand our breakeven analysis. So 65,000, that means that 32.5% of every dollar is going to covering the bottom line. And so what would happen is in this particular case, I'm going to say, so $2, is going to contribute to my bottom line after every single deal. And in this particular example, we're going to have to cover $15,000 and $8,200. And so you're going to pull out your calculator. I want you to pull this out and do this with me. Pull out your calculator. You're going to say $15,000 plus $8,200. These are your two fixed expenses, $15,000 in payroll, $8,200 in rent, office utilities, and office equipment. That goes to $23,200. And then we are going to 36 installs to break even. This is called a break even analysis.

Starting point is 00:17:34 Now, you might have multiple products. You might have your customer that only does like you might have roofing as one product. You might have windows as one product. So really understanding how much of each of those is an average. What is my average roof worth? What is my average HVAC system worth? What is my average this, that, or the other? The more closely you can get to an average is going to be able to help you better understand your breakeven analysis. So now I know that I have to install 36 to breakeven, to cover my nut, to cover my fixed costs every single month, which is, once again, my rent, my utilities, and my office equipment, plus my fixed payroll, which is about $15,000. That will cover it. Every dollar above that,

Starting point is 00:18:28 I am going to get 32 and a half cents in revenue that goes to my bottom line. So the first 36 installs, I make zero zilch. It's there to cover, right? And so understanding this, you never want to kick an install to the next month because then if it gets kicked to the next month, it's just going to be going to help contribute to breaking even where if you can capture it this month, this is why it's so important to get work done in a certain period because you don't have additional fixed expenses associated with that. You're going to be able to capture the full 32 and a half cents for every dollar of revenue. This is what you have to understand and why it's so important

Starting point is 00:19:14 to go and spend the additional money. You need to understand, where do I have additional capacity? So hold on. I apologize. I might be speaking over where you're at, but hopefully you're following where I'm at. You need to ask yourself, what additional capacity do I have to fulfill on product? Because there's certain things that are fixed, right? Your rent, your crews or whatnot. Do your crews have the ability to perform more? Can you run more crews out of your current office space? If you can, every single dollar in, in this particular example, is going to be 32 cents to your bottom line. Okay. I need you to really, really understand that. Now there's going to be certain expenses. Come back to the iPad with me that you're going to be, say, you're on an XY here.

Starting point is 00:20:08 Right. And this is a certain level of expenses. As as you grow and you get too big, you're no longer going to be able to do that. You have to add a office space. You need to understand that when you sign that new lease or you expand into that new fixed cost, that there is a certain amount of installs or products delivered that have to now be contributed to breaking even. So every additional hire, every additional expansion is going to cost you more money in fixed cost. And this is where, you know, a lot of entrepreneurs get lost is like, oh yeah, that seems I have money in the bank account, right? We get in this habit of running our business purely off of the amount of money that we have in the bank, right? Like say I have $250,000 in my bank account and I go and I sign a new lease that is going to cost me $5,000 a month and you calculate, well, that's $60,000 a year. I have 250 grand. Of course, I can afford

Starting point is 00:21:12 that. Let's go. Instead of actually looking at the analysis of what is that $5,000, what did that $5,000 a month actually make me go and spend? So let's say in this particular example, you wanted to add $5,000 in additional expense every single month and that you're getting $650 contributed to covering expenses. So let's once again bring out our handy calculators. Okay. So we're going to go 5,000 divided by 650 put that into your calculator and you're going to get there we are 7.69 so eight if I were to increase if I were going to increase my my expenses let's go up here so if I increase these expenses by $5,000, every $5,000, I'm going to have to do eight more installs every single month. That's a completely different decision and strategy than just thinking, do I have enough money in my bank account to cover

Starting point is 00:22:19 for the next 12 months? That should never be the decision process. It should always be, will this, if I add this, how much more do I need and what more value will it bring? If I add an additional location and I know that my current location is doing a hundred installs every single month, an additional location is going to allow me to go to 200 installs every single month, then it's probably worth it. But understanding that in the short meantime, I'm going to allow me to go to 200 installs every single month, then it's probably worth it. But understanding that in the short meantime, I'm going to have to do eight more installs every single month to cover my nut. My nut is no longer the 36. You take the 36 plus the eight. It's now the 44 installs every single month that I have to do to break even. This does not

Starting point is 00:23:07 include any additional utilities. This does not include any more office expense or employees that you're going to after. All those things need to be factored in to how this is going to impact my break even analysis. So now what I want you to do, and this is going to be a little bit longer than exercise, is to pull that income sheet back out. And you need to first understand your unit economics of my average cart value or my average system size or system revenue or whatever it is. Okay. How much is that? Then you need to understand your gross profit margin, gross profit margin as a percentage. Okay. What is it? Remember, we're adding up sales and marketing. We're moving it above the line. So whatever your gross profit is, you need to eliminate this. And that's your real gross profit because your cost of acquisition

Starting point is 00:24:11 needs to go into there. And then you're going to be able to understand that for every dollar. So let's say your gross profit margin is 30%. That means for every dollar of revenue that you collect, 30 cents is going to go to covering your fixed expense until it's covered. Once it's covered, then now you know what your breakeven is. So I want you to calculate how many of your average systems, your average sales or whatnot, does it take for you to breakeven to cover your fixed costs every single month? I need you to figure this out. I know this sounds tedious and this is difficult, but I really need you to buckle in on this. What is it? Look at that information. Hopefully you're looking at it right now for your

Starting point is 00:24:57 income statement. What is your break even? Okay. Now ask yourself, how much does every single dollar after break even? The answer is if you're 30%, it's going to be 30 cents for every system. Then ask yourself, what is my capacity? Do I have capacity for more productivity with all my fixed costs, with my current staff, with my current office space, my trucks, everything? Do I have more capacity to add work to them? If you don't and you need to add additional space, ask yourself, how will that impact my break-even? Going through this exercise, work it out. We'll see you on the other side.

Next Level Pros - #111: Income Statement Explained and How to Use it to Grow

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