Income Statements and Balance Sheets

L 5

Ing. Jiří Šnajdar 2014

The ability of managers to make sales and to control expenses, and thereby to earn profit, is measured in the Income Statement.

Managers must also control the financial condition of the business. This means keeping the assets and liabilities within proper limits and proportions relative to each other and relative to the sales and expense levels of the company.

Profit performance alone does not guarantee survival. And to do this well, you must understand the income statement and balance sheet in addition to the cash-flow statement.

At the end of the day, when all of your books have been sold, when returns have come back, when bills have been paid and receivables collected, you want to have a record of exactly what kind of month, quarter, and year you’ve had, and what shape your company is in.

The income statement and balance sheet provide you with the answers to these questions.

How much money do you have left over (the gross profit) after you’ve reduced your sales by the actual cost of goods and royalties?

How much do you pay in salaries relative to your net revenues? The result of subtracting expenses and taxes from revenues is the company’s net profit.  

The balance sheet, on the other hand, looks at your business at a very specific moment in time.

It tells you how your company is doing on that particular day. 

The Income Statement

For most publishers, the income statement is the foremost management tool at their disposal.

Because it reflects what’s happening over time, it allows you to view and monitor progress of the business throughout the year by comparing the actual dynamics and results of the company or division with those you’ve projected in the budgets.  

Why are revenues lower or higher than projected? Why is cost of goods higher or lower? Why are costs in various areas off the mark?

What does the income statement cover and why is it important? It covers every aspect of your business:

• Sales• Expenses• Taxes• Profits

As noted, the formula is simple: sales minus expenses and taxes equals profit. 

Sales – (Expenses + Taxes) = Profit

How is the initial income statement used as a budget?

You want to project as early as possible those revenues and costs you will incur throughout your year, whether it’s your first year in business or your twenty-fifth.

How is the initial income statement used as a budget? How is the initial income statement used as a budget?  

You want to know where you’re going throughout the year.

What are your financial goals? You don’t want any negative surprises.  

Begin with revenues. You’ve already estimated revenues in your sales budgets, so these should be in good shape. Don’t forget that for income statement purposes, we’ll have at least three summary lines of revenue:

• Gross sales • Returns • Net sales

In publishing, gross sales is derived by adding the returns amount to net sales. In other words, net sales plus the returns amount equals the gross sales.

Net Sales + Returns = Gross Sales

Total sales, then, equals:

Gross Sales – Returns = Net Sales + Other

Publishing Income = Total Sales

Returns: You’re more likely to have higher return rates than lower. So be cautious in the beginning. (20 % 30 %)

Because net sales always equal 100%, the addition of other publishing income can provide a significant boost to your total sales line.

The first kind of expenses that you must recognize are those that relate to the cost of your products themselves; that is, your cost of goods.

1. Your actual development costs, including editing, copyediting, permissions, photography, design, getting the manuscript into printable form, etc. These one-time costs are also called plant costs. Plant costs can be written off, or amortized, completely in year one, or proportionately over a few years. Ask your accountant about how yours should be handled.

2. The cost of actual paper, printing, and binding

3. Royalties

4. Freight in

Totaling all of these and subtracting them from your total sales tells you your gross margin. After subtracting direct provisions, the result is your gross profit. (50%)

Following the gross profit line, we begin to list our direct expenses and operating expensess.

Subtracting these expenses from the gross profit results in your contribution to profit line.

This is also called EBITDA or Earnings Before Interest, Taxes, Depreciation, and Amortization.

Subtracting the taxes leaves you with your net profit.

Net profit is crucial, because this is where the net funds for such growth can come from.

At the same time, you must manage to get your contribution to profit line as high as possible.

If you do this, the impact of taxes may still leave you with a net profit.

The Balance Sheet

As noted above, the balance sheet tells us what the company looks like financially on a specific date. What the balance sheet really does is to summarize three factors that tell you where you stand as a business:

• Assets, or what you own• Liabilities, or what you owe to others• Owner’s Equity, or capital, which is the difference between assets and liabilities, and which reflects the owner’s share of the business.

How does the balance sheet summarize this?

It balances the three elements above in an equation:

Assets = Liabilities + Owner’s Equity or Capital

Assets are things you own. They are primarily tangible. The only intangible asset for accounting purposes is goodwill.

Assets include:

Current Assets

• Cash• Accounts Receivable• Inventory• Prepaid Assets (work in process, advances, etc.)

Long-Term Assets

• Plant and Equipment• Goodwill

Liabilities include:

Current Liabilities

• Accounts Payable• Royalties Payable• Taxes Payable

Long-Term Liabilities

• Notes Payable

Owner’s Equity consists of:

• Stock• Retained Earnings• Year-to-Date Profit

Assets. This is what you own.

Cash. First, note the amount of cash on hand.

Accounts Receivable.

A/R is another key asset. This is the result of the sales you’ve made that are yet to be collected from your accounts.

Inventory. Here is your third primary asset. This is what you’ve produced and is sitting in your warehouse. This is money tied up.  

Cash and accounts receivable are usually called liquid assets because they are or can be turned into cash relatively quickly.

 

Liabilities.

This is what you owe.

Accounts Payable. This is the primary liability account used every day.

Royalties Payable. These are the royalties accrued and owed to authors for books you have sold.

Taxes Payable. These include unpaid taxes of any kind, particularly payroll taxes.

 

Notes Payable.

If you’ve borrowed money from a bank or from any other person or organization and you’ve signed a promissory note to pay that loan back, then you will have a loan payable on the books.

Loans payable almost always require the payment of interest.

 

Owner’s Equity.

Owner’s Equity is composed of three elements:

• the value of common stock outstanding• retained earnings from prior years• the year-to-date net profit

 

Working Capital is the difference between current assets and current liabilities.

Current Assets – Current Liabilities = Working Capital

If positive,…..

If your working capital is negative,…

Working capital is critical to your company.

 

Current Ratio is simply the total current assets divided by the total current liabilities:

Current Assets/ Current Liabilities = Current Ratio

Most financial institutions look closely at this ratio before deciding whether to make loans.

A current ratio of 2:1 is considered good.

 

Quick Ratio is similar to the current ratio, but only takes into account those assets and liabilities that can be converted to cash quickly if a crisis hits.

Current Assets (excluding inventory)/ Current Liabilities = Quick Ratio

 

Return on Equity (ROE).

the ratio is:

Net income/ Stockholder’s Equity = Return on Equity

In publishing, a return of 15% or more is considered very good.

 

Create a Board of Directors

An excellent way to keep control of a small or midsized company and to keep perspective on it is to establish a board of directors.

Board members should be chosen not because they’re friends, but because they can help focus your business. Some may be publishing experts. You may want a lawyer, an accountant or banker, a marketing expert, a manufacturing expert.

A board of directors should have regular meetings, probably two per year.  

Each meeting should be well structured and planned far enough in advance to give those attending the chance to review materials and think about them.

In advance of the meetings, you must provide a synopsis of the company in the form of income statements and balance sheets, but also in the form of up-to-date budgets and cash-flow charts.

Where do you stand in relation to your budgets?  

You’ll probably want to have your functional managers talk about their areas, and inform the board about how sales are doing and other matters that may need to be evaluated objectively.

You don’t want your board to be yes-people.

You do want them to be active participants in the management process. If your management technique needs refining, let the board tell you.

If you need help getting a bank loan, let the board give you perspective on it.

Keep Your Staff Lean

With the mission statement, goals and objectives, budgets, cash-flow projections, and job descriptions in hand, you are ready to staff your company.

The theory is that if each member has special talents, with good experience and contacts, those attributes can be brought to bear on the new venture with the result that new authors and manuscripts, better production terms, expanded sales, and attentive publicity will result.

That’s the theory.

The reality is often the contrary. Good people cost good money—perhaps more than you’ve budgeted.

The point here is to be careful, be conservative, and be cautious.

On the other hand, don’t wait too long to hire the staff you need to be effective.

• President/Publisher to guide the business, acquire, and edit

• Sales & Marketing Manager

• Finance/Business Manager

• Production Manager

• Assistant

This certainly covers all of the functional bases.

However, does it make sense given your current and future sales goals and budgets?

If you need additional help, you can find it temporarily by using freelance contractors who can be paid strictly for the work they do. You need to ensure your success:

• Editorial acquisition and development• Sales

What it does mean is that every publisher must control and oversee its sales from in-house.

Without this essential knowledge, the company can’t plan properly or understand the dynamics of its book sales and of the market itself.

Publishing in general has traditionally been an industry of high turnover where promotion comes through the acceptance of a new job with a competitor, not primarily from internal recognition.

Good management encourages people to grow within their roles and to learn more about the company as a whole.

Ultimately, it allows good employees to expand those roles and take on new ones as they develop the necessary expertise.