Kristin Gleitsman

Leadership in Biotech

Tag: Scientists

Income Statement Fun: What is included in the Cost of Sales and why you should care

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On September 7, 2023

In Finance for Scientists

In this post, we’ll continue our foray into the Income Statement and dig into costs and expenses, part 1: ‘Cost of Sales.’

Let’s go back to the BioTechne Income Statement from last time:

Screenshot of Bio-Techne Income Statement

You have net sales (revenue) at the very top, followed by the cost of these sales. Recall that one of the first things we learned about BioTechne was that ‘Bio-Techne Corporation is a global life sciences company that provides products and services for research and clinical diagnostics. Because they provide both products AND services, the cost of sales here includes both the Cost of Goods, or CoGs, that many of us are familiar with (i.e., the raw materials used in manufacturing) and Cost of Services.

Just like with revenue, there is nuance to what is and is not included in ‘Cost of Sales.’ And these nuances are important for anyone leading a scientific (or even operations) function to understand because it can frame the performance of your department to corporate and play into how your department’s targets are set.

Finance for Scientists

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Here are three examples:

  1. Let’s say you run a Biopharma-focused informatics team at a diagnostics company. A large part of what your team does is interface with your biopharma clients to understand their needs and return the right kind of analysis. But you also work on algorithms that are used in your company’s core bioinformatics pipeline. Finance could reasonably justify putting your team’s salaries as either part of the ‘cost of services’ or part of ‘R&D.’ This choice, however, will heavily influence how much scrutiny there is, as things ‘above the line’ (i.e., in the first block of items on the income statement) usually face far more scrutiny than those below the line, especially if your margins are low.
  2. Let’s say you run a scientific operations team. You will probably have specific CoGs targets to hit each quarter that are a big part of how you and your team are evaluated. In reviewing the numbers, you realize that there is an item around ‘contract administration’ listed against your CoGs. Does it belong there? Can you reclass that as G&A (general and administration)? If you do, your numbers are going to suddenly look better, so in a bad quarter, you may be tempted to push for a reclass.
  3. Imagine you are in charge of running a CLIA lab at a diagnostics company. Some part of the environmental controls (i.e., air conditioning and heating) control the temperature of the CLIA lab space, and some part is used for the office space. What portion is attributed to ‘Cost of Sales’ and what portion should go under G&A (general and administration)? Do you use square footage? Do you allocate the cost in the same way for IT expenses?

Just like with revenue recognition, there is a large amount of discretion allowed here, but it’s also easy to see how things can get wonky.

That’s the basics for costs. We’ll go through expenses in the next post. As always, you can join the mailing list so you don’t miss it!

A stylized illustration showing how earning revenue is discrete from creating, delivering or even selling products

What scientists need to understand about revenue and its recognition

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On August 31, 2023

In Finance for Scientists

Today we will talk about revenue.

Revenue seems like a pretty obvious concept: the dollar value of the products and services a company provided to its customers during a given period of time (remember the ‘Matching Principle’ we talked about in the last post?). 

There are some subtleties here, because in order to record something as revenue, it must have been ‘earned.’ If you are selling a reagent, then you must have shipped it to your customer. If you are performing a service, say running a diagnostic test, then you should have performed the work. Easy enough? Sure, but consider:

Say BioTechne allows a customer to order reagents ahead of when they will need them (for instance, maybe the customer is looking to control the number of lots they have), but because this is a particularly important, high volume account, BioTechne is willing to hold those particular lots of reagents until the customer needs them (i.e., you haven’t shipped them yet). When can they recognize that revenue?

Or let’s say the diagnostics side of the business, ExosomeDx, signs a multi-year pharma contract for processing and analysis of clinical samples. When do they get to recognize the revenue from that deal? When the samples are run? Or when the complete analysis is delivered to the client?

Let’s keep these points in mind as we look through the numbers. 

Below is the screenshot of the income statement for BioTechne:

Screenshot of Bio-Techne Income StatementYou have Net Sales, i.e., Revenue, listed at the very top. Yet another place where different terms are used for the same concept. If we look at the income statement of another company in the space, Beckton Dickenson, their top line is called out as Revenue.

Screenshot of Becton, Dickinson and Company Income Statement

Finance for Scientists

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When revenue reporting isn’t black and white

As we saw in the examples at the top of this post, there can be a fair amount of nuance in when and how to recognize sales, and tremendous pressure to make this figure look strong. And because of this, the place where the most accounting shenanigans happen is in revenue recognition. In fact, most accounting fraud occurs in the top line, but even non-criminal bias can land a company in hot water. 

A quick example of how (non-criminal) bias can creep in could be around service contracts when an instrument is sold. Let’s say customers purchase a 5-year service contract alongside an instrument. When do you recognize that income? The service at year 0 has not been rendered, so you can’t recognize all the revenue, but you can claim that most of the cost of that service contract has been in making the initial sale, so 75% of the revenue should be recognized up front. Equally legitimate would be to say that only a small percentage of the revenue should be recognized up front, because most of the cost is associated with servicing that machine down the line. It’s really a judgment call that depends on the particularities of the business. 

What’s interesting is that you can even change your revenue recognition strategy, although generally it’s fairly suspicious to be doing this often (remember “consistently applied” from the last post?). If there is a change in revenue recognition strategy, it would be called out in the footnotes— another reason why it’s not a bad idea to look through them. 

Another example of bias and uncertainty in revenue is the quality of the customer.  Will the revenue shipped actually be paid for? Have you given special consideration to the customer (6 months to pay for example)? Have you made promises (warranty) that the product will perform down the road (a product warranty)?  All of these factors can contribute to revenue uncertainty.  

Depending on where in an organization you sit, scientific and technical decisions you make may impact revenue and its recognition. Are you developing a stand-alone product? Is it part of an ongoing delivery schedule? Are other services attached to it? These questions might color the response your work gets from other stakeholders in your company if they’re targeting a particular revenue goal.

Those are the highlights for revenue. In the next two posts, we’ll get into the murky realm of costs and expenses. Make sure you’re on the mailing list so you don’t miss it!

Stylized illustration of a scientist examining an income statement, a balance sheet, and a cash flow statement

Every scientist’s dream: Understanding financial statements

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On August 16, 2023

In Finance for Scientists

Every company that trades on the stock market has to share their financial results every three months, i.e., quarterly. Once a year, they produce an annual report, which is basically a blown out version of these quarterly documents.. You know those “10-K (annual reports) and 10-Q (quarterly reports)” we found for Bio-Techne on EDGAR? That’s what I’m talking about. 🙂

There’s quite a bit you can learn from these documents, but here we will focus on the financial statements.

The main statements are

  • the income statement,
  • the balance sheet, and
  • the cash flow statement.

These statements are not just for life sciences companies. All companies that trade on the stock market are required to file these documents. Nonprofit organizations and government agencies use similar statements, although there are a few key differences we won’t cover here.

The income statement shows us how much money the company makes. This statement matches the expenses with the revenue, so one can see how efficient the company is at making money.

The balance sheet shows us what the company has (i.e. its assets) and what it owes (i.e. its liabilities). The difference between assets and liabilities is equity, the part that belongs to the owners/shareholders of the company.

The cash flow statement simply tracks how much money is coming in and going out of the business over a period of time. As soon as money moves in or out, the cash flow result is recorded.

Finance for Scientists

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Putting together the full picture

These three statements together give us a clear picture of how well the company is doing financially. Of course, there’s considerable nuance in how a company approaches these statements that can impact how well or poorly it looks like it’s doing. There are rules governing accounting and finance, but there’s also quite a bit of art to it, and when companies get too creative or allow significant bias to creep in based on market pressure, that’s where you start to head towards fraud and financial ruin. We’ll cover that along the way, too.

One way to think about accounting is similar to the way you would run a scientific experiment – In an experiment you have controls – to measure the result vs a comparison point.  One of the most fundamental accounting rules for GAAP (Generally Accepted Accounting Principles) is that GAAP is consistently applied- so you have a control in place and can do valid comparisons between quarters, years and months, just like a good trial or experiment.

These financial statements are the gold mine of information that stock analysts use to figure out how much these companies are worth, and what their stock price should be.

While stock analysts also look at other data outside of these basic financial statements, even if you only had the data in these statements, you’d have a strong understanding of the company’s past performance and current state. And from there, with some insight into the market that the company operates in, you can start to make some predictions about the future.

In the next part, we’ll explore the income statement. We’ll go through the structure of it, then we’ll look at some real world examples.

Stay tuned! (Which is easier if you join my mailing list to be updated when the next installment comes out.)

Stylized illustration of a scientist looking through financial documents and reports

How to learn the financial basics about a new (to you) business

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On August 11, 2023

In Finance for Scientists

Before we start exploring financial statements, let’s start with the basics on where to find information about a life sciences company with which we’re unfamiliar.

Let’s take the example of Bio-Techne Corporation.

Maybe you’re already familiar with Bio-Techne Corporation. Maybe not. Either way I bet you will learn something from digging through their financial statements.

Our first step is to go to the Electronic Data Gathering, Analysis and Retrieval (EDGAR) tool from the US Securities and Exchange Commission (SEC):

https://www.sec.gov/edgar/searchedgar/companysearch

You can type “Bio-Techne” in the “Company and Person Lookup” field. As you type, automatic suggestions will be displayed below the search field. Once you see Bio-Techne, click that suggestion. If you simply click the gray “search” button on the right, you will be taken to a much broader page of search results instead of the page specifically for Bio-Techne.

Alternatively, you can search Google for “Bio-Techne stock”, find that its stock ticker is “TECH”, and put “TECH” in the “Company and Person Lookup” field instead.

On the right, you’ll see “10-K (annual reports) and 10-Q (quarterly reports)”, click the “+” sign, then open the most recent 10-K, which was filed on August 24, 2022.

Screenshot of the EDGAR listing for Bio-Techne, with the 10-K and 10-Q section highlighted

Look for the 10-K and 10-Q section on the right

10-K Overview

You’ll see a table of contents, where you can click on “Item 1. Business”. The very first section there is titled “Overview”

Here’s a summarized version of what we find

  • Bio-Techne Corporation is a global life sciences company that provides products and services for research and clinical diagnostics.
  • The company operates in two segments: Protein Sciences and Diagnostics & Genomics.
  • The Protein Sciences segment offers proteins, antibodies, immunoassays, cell and gene therapy solutions, and instruments for biotechnology and pharmaceutical customers.
  • The Diagnostics and Genomics segment offers molecular diagnostic products, cytogenetics media, and clinical controls for clinical laboratories and hospitals.

Fantastic!

Even after this little bit of reading, we have a good sense of what Bio-Techne Corporation does. It’s a products and services company in protein sciences and diagnostics/genomics. In other words, they provide reagents and instrumentation to researchers for both research and diagnostic test development and deployment.

Finance for Scientists

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Business Risk Factors

Now let’s move to “Item 1A. Risk Factors”.

This is where management lists the risks to business success.

Even beyond risk management, it gives us a good understanding of how the business runs.

For example, Bio-Techne lists 6 fairly generic categories of risk, with each section having more detailed risks listed:

  1. Economic and Industry Risks
  2. Acquisition and Investment Risks
  3. Strategic and Operational Risks
  4. Intellectual Property Risks
  5. Financial and Tax Risks
  6. Legal, Regulatory, Compliance and Reputational Risks

These are my learnings from the risk factors (see if you agree or have others to add):

  • There are a good number of risks related to supply chain and manufacturing concerns: getting raw materials, forecasting and scaling manufacturing appropriately, being able to get finished goods to customers.
    • Many of these risks were realized during the pandemic, and you can see this reflected in the numerous references to COVID-19 throughout the risk section.
    • Most of these risks would impact any business in this space to a large extent.
  • There are also a good number of risks around operating in the highly regulated healthcare space, which are shared with other players in the industry.
    • One particularly interesting note here is the privacy and security regulatory risk due to the acquisition of a diagnostics company, “a risk that has been elevated with the acquisition of Exosome Diagnostics, whose laboratory testing service is a healthcare provider that obtains and uses protected health information.”
    • i.e., they didn’t use to be directly in the diagnostics services business and now they are and it carries a different level of risk.
  • You can also tell that this business is fueled by innovation through references to risks around hiring and retaining highly skilled workers and protecting intellectual property.
    • Risks may not be uniformly shared across the healthcare sector, but these are fairly standard fare for the life sciences.
  • You can also see specific financial risks related to Bio-Techne, in particular around their Credit Agreement that bears interest at a variable rate and the fact that they are subject to risk from exchange rates due to their international presence.

Even if you’re familiar with a business, it’s worth going back through “Item 1. Business” and “Item 1A. Risk Factors” in its most recent annual report.

Start here, and you’ll have a foundation for the analytical work to come. Along the way, we’ll also dig into what some of the financial terms in the risk factors mean and how they impact the business. To keep up with this series, consider joining my mailing list to be updated when the next installment comes out.

Illustration of a scientist explaining business finance concepts

Why am I writing about finance?

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On August 7, 2023

In Finance for Scientists

Many scientists and engineers I’ve worked with have expressed frustration at not being able to have the kind of influence they want over the strategic directions of the companies in which they work. Oftentimes they feel their perspectives are being dismissed, particularly in discussions with colleagues in other functions.

But in the wise words of a mentor of mine, ‘if you want business people to listen to you, you have to be able to speak in a language they will understand.’ That language is, by and large, the language of finance. If you can frame the opportunities you see in language that your non-scientific colleagues can easily understand (and then explain to the board of directors), your ideas are much more likely to gain traction.

Similarly, scientific leaders will be better equipped to identify and prioritize scientific programs and investments if they can connect the dots between technical advancements and the ever-important bottom line (which, it turns out, refers to an actual line in the income statement!).

So my hope is that when armed with a little better financial intelligence, scientists and engineers can start to bridge the gap between the technical aspects of our business and the business end of the business.

Of course, I myself am one of these scientists. And so a big part of why I am writing this series is to force myself to dig deeper into some of the learnings I have gleaned from books, podcasts, and articles along the way (including frantically looking up terms like GAAP and EBIDTA during earnings calls and executive meetings). By virtue of my scientific background, hopefully the language I use throughout this series will be a little less opaque and a little more understandable for those of us who are more likely to be reading Nature articles than the Economist.

Specifically, in this mini-series, we will cover:

  • Some basics on financial statements
  • The big three financial statements (and their component parts):
    • the income statement
    • the balance sheet
    • the cash flow statement
  • Key ratios or evaluating the financial health of a business
  • Numbers investors care about and why
  • How to understand whether a new project/investment has (financial) merit through Net Present Value

Finance for Scientists

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To start, a couple references and an important acknowledgement. My initial foray into the wonderful world of finance was inspired by my friend Jeff Krimmel’s frequent LinkedIn posts on business and strategy in the energy sector. Jeff and I met as PhD students at Caltech, and I have been awed by his seamless transition from hardcore engineering to business and strategy, and am always impressed by his insightful discourse. I highly recommend checking out Jeff on LinkedIn and perusing his mini-course on Energy Finance. You’ll notice that this course closely mimics his course in places (with his blessing).

Another important source here is the book, Financial Intelligence. A Manager’s Guide to Knowing What the Numbers Really Mean, by Karen Berman and Joe Knight. It’s a great read and has many details that I won’t cover in this series.

In any case, I hope you enjoy! I would love to hear your questions, thoughts, and comments along the journey. And if you are really keen, join my mailing list so you don’t miss the future installments of this series.

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