Important Income Statement Terms and Matrix

By Bob Ross

Important Income Statement benchmarks and terms in small business valuation

Gross Sales (also called Gross Revenue): measure of overall sales not adjusted for discounts or returns.

Net Revenue: sales minus discounts or returns.

Cost of Goods Sold (COGS): are only those costs that are directly tied to the production of the product whether labor of material.

Gross Profit (also called Gross Margin and Gross Income) is Net Revenue – COGS

Gross Profit Margin: financial metric used to determine firm’s financial health calculated

Gross Profit Margin = Net Revenue-COGS/Revenue

Other Income: sources of other equipment include selling investments or equipment.  See “Beware of Other Income” blog for cautions and observations.

Total Income: Net Revenue- COGS + Other Income

General  & Administrative Expenses (SG&A) (also called Operating Expense): the sum of all direct and indirect selling expenses and all general and administrative expenses of a company.  See “What SG&A can tell you about a company” blog

Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA): a calculation that allows comparison between companies and industries because it eliminates the effects of financing and accounting decisions.

Note: EBITDA is a non-GAAP measure that allows flexibility as to what is included in the calculation.  It is not a measure of earnings but a good matrix to evaluate profitability.

Operating Income ( also called Earnings Before Interest and Taxes (EBIT), Operating Profit, or Recurring Profit): The amount of profit realized from a business’s operations after taking out operating expenses - such as cost of goods sold (COGS) or wages - and depreciation. Operating Income takes the gross income (revenue minus COGS) and subtracts other operating expenses and then removes depreciation. These operating expenses are costs which are incurred from operating activities and include things such as office supplies and heat and power.

Total Income – SG&A – Depreciation and Amortization

Normalized Earnings (also called Adjusted Earnings): earnings are adjusted by adding back expense items that relate to owners benefits, financing, accounting decisions, and other discretionary items.  This matrix helps show the true earnings of an operation.

Lender Customary Add-backs: expense items that most lending institutions allow to be added back to arrive at Seller’s Discretionary Cash Flow.  Typical expense items added back include Owner’s salary, vehicle, insurance, medical, payroll taxes, travel and entertainment (not directly related to the production and sale of its products or services).  Other items allowed are non-essential telephone, utilities, and legal expenses.  Depreciation, Amortization, Interest and unusual non-recurring debt are almost always added back.  Rent paid must be added or subtracted to reflect market rents.

Seller’s Discretionary Cash Flow: The amount of money left over after the new owner pays operating expenses to pay themselves and the dept service.

Excess Earnings: The amount of cash remaining after operating expenses, normalized manager’s/owner’s salary, and debt service are paid.  One of the most common valuation methods for valuing small businesses is Capitalization of Excess Earnings (COEE).

Commercial Viability Ratio: Most lenders require that a normalized cash flow cover debt service by at least 150%.  To calculate:

Debt Service/Sellers Discretionary Cash Flow – Normalized manager’s owner’s salary