This is part two in our series, “Finance: Storytelling with Data.” You can read Part One, the intro, here.
Your income statement helps you tell the story of what your company has achieved so far. Understanding not only this, but also how you accomplished those results will help you learn what works for your company and make informed decisions for the future.
This question is answered by looking at the last two years of your 5 year functional income statement, which we discussed in part one. You can go back more than 2 years if you’d like, but when dealing with startups and how fast things change, information from 3 years ago may not always be relevant today—and could muddy your story.
First off, you might be asking: what is a functional income statement? A functional income statement is just a fancy way to say organizing your expenses by department/function. As you can see below, our income statement breaks out sales & marketing, research & development, and general & administrative costs separately. A functional income statement is important because it gives you and your investors visibility into where exactly your business is spending money, and, as we will learn about in a later post, whether that money is bringing a good return on revenue.
Preparing a functional income statement starts with your accounting data. You’ll need to assign each transaction to the right function. This will ensure that your spend is properly attributed so that you can accurately analyze your spend, ROI, channel performance, etc. Not sure how to do this? Here is a step by step guide for QuickBooks users.
Now that you have your functional income statement, it is time to answer the question: what have I achieved so far?
Look at your revenue—how much do you have? How fast is your revenue growing? Has growth been increasing, decreasing or staying the same? Look at your expenses—how did you achieve that growth? Did you increase your spend in sales and marketing? Maybe you developed and released a new product, demonstrated by higher R&D costs. Whatever it may be, take note of which functions you are investing the most money into, and examine how those costs have been growing.
Let’s take a look at the following example income statement, see how some of the financial data below can illustrate about a business over the past two years:
Remember: we’re here to show how your financial data can tell the story of your business. For our example income statement above, the numbers could be supporting the story of a maturing company—which may go something like this:
“My company has had steady year over year growth. However, it declined slightly from last year. We increased our investment in the sales team, but as the market becomes more saturated, it’s becoming a little harder (and more expensive) to sell our product. So while we are now spending 17% of our revenue on sales and marketing costs, it only led to 29.7% growth last year (compared to spending 12.3% last year and having it generate 39.9% growth).
Despite the slowdown in growth, we actually increased our profitability at the end of the day by realizing some overhead cost savings, as seen in the decrease in G&A spend. We plan to share some of these profits with our investors as a distribution next year.”
Alternatively, the story could be one of a global pandemic.
“Despite the COVID-19 pandemic we still were able to grow almost 30% last year! Once the pandemic started, we put a pause on our ambitious hiring plans. However, due to the new sales team members we brought on pre-pandemic in Q1, we still had higher costs there for the year. We expect this investment on our sales team to help lead to higher growth once the economy recovers.
We made it a goal to not have any layoffs during the pandemic. Instead, we found some cost savings in our office space, travel, and general software spend to make sure we still remained profitable at the end of the day. Good job team! We are set up well for success next year.”
As you can see, the numbers could be the same for two companies, but lead to two different stories. It is important to think about what happened within the specific context of your company over the past couple of years, and then use your numbers to back it up.
The biggest mistake I see is when companies tell a story that is contradicted by their numbers. This often happens when people come up with the story without looking at their data. As demonstrated above, even if the numbers aren’t what you hoped for (e.g. slow or no growth) try to reframe the story and focus on some positives (e.g. increased profitability, less layoffs, etc.).
With an understanding of what your income statement is showing, you can confidently tell the story of what your company has achieved in the recent past. Moving forward, I’ll talk about answering the question of how your company will grow in the future—and how to share that story using—you guessed it—your financial data.
As always, I’m more than happy to answer any questions you might have about creating a functional income statement and using it to tell your story. Drop us a line to get started.