Day 2 – Income Statement

9 May

Well I survived the first day of my faux Harvard MBA. Day 2 is going to involve my insights on the Income Statement. I am departing from yesterdays format and will just provide some interesting insights that I think might be helpful to future budding venture capitalists. For a more detailed analysis you will need to follow the links I provide…I will be back later tonite…and there will be hell to pay if I can’t find good content ¬†ūüôā

(ultimate demarcation line)________________

Okay I am back, disclaimer…no brilliant insights from a couple hours of studying the income statement. ¬†I did find a nice post on the income statement from Fred Wilson. His big thing is profit margins and operating income ( no surprise here).

(Revenue – Cost of Sales) / Revenue = gross profit margins

He looks for companies with high gross profit margins because they have ample cash left over after making a sale and can pay for other expenses of the business. Buffet is big on this number as well. Particularly trending numbers over a period of years, which may indicate a sustained durable competitive advantage. This advantage may derive from operating in an industry with a high cost of entry (think drilling for oil), or certain patents preventing other entrants. Breaking out the cost of revenue is critical too, because it can change (positively or negatively) with increasing revenue.

Fred also emphasizes the importance of operating income, or income after expenses. If positive you are in the black and making money, if negative you are losing money. For a start-up you may start-out in the red as you attempt to scale your way to profitability. Great gross profit margins and good breakthrough top line sales (at least initially) may not be enough to cover operating expenses. But if the company is structured properly and operating expenses / fixed costs are controlled over time, you could be well on your way to profitability.  Fred likes to see income statements for start-ups broken down month by month for the course of say a year. This will give him a sense of how revenues, costs and profits are trending.

Remember numbers can be deceptive and don’t tell the whole truth. Simply looking at the income statement speaks nothing about employee moral, how great the product is, how engaged management is, or a host of other intangible factors, which are critical to the success or failure of a business.

Thanks Fred and Buffet.

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