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In this video, we continue our look at the income statement and dig into the expenses section. You'll learn about different types of expenses, including cost of goods sold (or COGS), and how to calculate expenses to determine gross profit from sales.
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. :-)