Income Statement: Cost of Goods Sold, Gross Profit, Expenses

Video #3


So you know now that the income statement starts off with sales at the top and then we start subtracting a variety of costs until we end up with net income at the bottom. So now I want to dig into what some of those costs are.

So here you actually see a heading called expenses and then underneath, a variety of expenses. But you’ll also see here, we have a special line called cost of goods sold and this is a special kind of expense. It relates to sales. When you sell something, let’s say a widget, the widget will have a cost. If you sell the widget for $1 but you’ve paid 25 cents for that widget, then the cost of goods that you’ve sold will be 25 cents. If you sell 100 widgets at $1 each then you’ll have $100 in revenue and 25 cents a widget times 100 of those is equal to $25 worth of cost of goods sold.

If you sell time by the hour, for example, if you’re a lawyer or a web designer or an accountant, then your cost of goods sold will be equal to the labour cost associated with whoever is charging that hour.  So if you’re charging $50 per hour for web design and you pay yourself $20 an hour, then your cost of goods sold would be $20 an hour.

And let’s just see how that subtotals. So let’s say that we had $10,000 worth of sales or revenue and our cost of goods sold was $2,500, we would have a little subtotal here. So that single line means we’re about to do a mathematical subtotal or a mathematical calculation like a subtraction. And, in this case, even though the $2,500 is shown as positive, we know that we need to subtract $2,500 from $10,000 to get $7,500. And this subtotal has a special name called gross profit. Now the words “gross profits” is often times not shown on the income statement but you’ll know what that subtotal is – gross profit.

Then underneath that, you’ll see that we have the expenses listed like this in alphabetical order. But we can also show them a different way, like this. Expenses are often shown grouped in three categories: general and administrative, which are all your administration costs like the salary of the boss, administrative staff, accounting people, rent, communications, those types of things; research and development are exactly that — all the costs and overhead associated with the people who are doing your research and product development; sales and marketing, similarly, all the costs and overhead associated with the salaries of the people who do your sales, marketing and your sales- and marketing-related campaigns.

Let’s just show you what happens when we add some numbers in here. Let’s say that general and administrative for the month was $3,000 in costs; research and development was $2,000; and sales and marketing was $1,000. What we would do here is we would total these. A subtotal of $3,000 plus $2,000 plus $1,000 is equal to $6,000. And then we would take the $7,500 of gross profit and we would subtract $6,000 from it. We end up with another special subtotal, so that would be $1,500. That special subtotal has a very complicated name which we will get to in the next video.

And you thought this stuff would be boring. :-)