There are a few financial reports that are essential for you to understand to operate a healthy business. Today we’re exploring your Profit and Loss Statement.
If you’re like most entrepreneurs, understanding and managing the financial aspect of your business isn’t your favorite thing to do. I get it – you didn’t start your business to analyze numbers all day. But the truth is without a solid working knowledge of your finances, you and your business will suffer.
What is a Profit and Loss Statement?
A Profit and Loss Statement (or P&L) is a “go-to financial statement that shows how much your business has spent and earned over a specific period of time” according to Bench.com. This report will show you all the revenue that has come into your business minus all of your expenses ultimately giving you your profit or loss amount.
When to prepare a Profit and Loss Statement?
While it’s typically prepared around tax season, ideally you should run a P&L monthly, quarterly and annually.
Running a P&L on a regular basis allows you to:
- Verify profits
- Stay on top of expenses
- Compare certain periods of time
- Understand seasonal trends in your business
- Make strategic business decisions to stay profitable
Your P&L will also serve as a crucial statement when looking into bank loans or investor opportunities as it allows others to assess your business’s success and risk level.
Components of a Profit and Loss Statement
Here’s a super basic breakdown of the various components of a P&L and where the numbers come from. Be sure to consult with your accountant and bookkeeper to ensure your books are set-up properly for your specific business.
The top line of your P&L is your revenue. You will sometimes also hear this called sales or income. Revenue is all the income (aka money) your business is bringing in during the time period designated for the report.
Remember revenue is before any and all expenses.
Some business owners like to lump all revenue together, while others like to break revenue into various categories to better see sales trends. For example, if you sell online and in-person you may separate revenue into two categories.
Cost of Goods Sold
Cost of Goods Sold (COGS) represents all the direct expenses involved in your business delivering your product or service. This includes items like materials and labor, but doesn’t include indirect expenses such as bookkeeping software.
Types of Expenses
Direct Expenses: These expenses are also referred to as Cost of Goods Sold (COGS) or Cost of Service (COS) and are directly related to the production and/or delivery of your product or service. This will include things like employee wages, and materials needed to create products.
Indirect Expenses: These expenses are also referred to as Fixed Expenses or sometimes “Selling, General and Administrative Costs” (SG&A). Indirect expenses aren’t traceable to production of the product and include items like rent and utilities. See Fixed Cost below for more details.
Gross profit is your revenue minus your direct expenses or COGS/COS. This number allows you to see if your delivery of the product or service is profitable.
Remember Gross Profit doesn’t include all the other costs needed to operate the business.
Your fixed costs are all the indirect expenses you incur in order to operate your business regardless of a sale. Things like rent, utilities, and paying your accountant go here.
This section of your P&L can be as detailed or simple as you’d like. Most accounting softwares have predetermined categories to help you figure out what expenses go where. And of course consult your accountant to be sure you have things set-up properly.
Net Profit (or Loss)
The bottom line of your P&L is your profit (or loss). You will hear this called Net Profit, operating earnings or “Earnings Before Interest, Taxes, Depreciation and Amortization” (EBITDA). This is your gross profit minus your fixed expenses.
Remember this does not take into account things like taxes, interest payments and depreciation. Those items are external costs you don’t have much control over, so it’s best to focus on Net Profit to understand your business’s health.
Analyzing Your Profit and Loss Statement
If you want to have a clear picture of the health and profitability of your business it’s essential to analyze your P&L on a regular basis.
Here’s some things to check:
Check Your Bottom Line
The bottom line of your P&L is your Net Profit. When this number is positive you’re in the black and profiting. If the number is negative you are in the red, your business is currently at a loss.
Remember your Net Profit is just one number in the bigger picture of your business’s status. Being profitable is great, but operating at a loss, especially in the beginning stages of entrepreneurship, is very normal. Plus, you’ll also need to check your balance sheet (more on that in a later post) for a more precise snapshot.
Assess your Income & Expenses
Once you know your bottom line number, it’s important to understand the nuances of your income and expenses. Understanding where your income is coming from allows you to better understand what product lines are doing well, what services or events are boosting revenue and if your income is in line with your goals. Having a clear picture of your expenses allows you to figure out where to make cuts if needed and more.
Compare Your Numbers
It’s important to compare P&L percentages in your bottom line as well as each income and expense category to previous periods to check for trends and changes. This way you know what’s working and not working in your business.
How to create a Profit and Loss Statement
Now that you know the basics of this essential report, you might be wondering how to create one. It all starts with staying on top of your bookkeeping. And that can be done in a few ways.
While it comes with a monthly fee, bookkeeping software is by far the easiest way to stay on top of your finances and easily run a Profit and Loss Statement.
If funds are limited and/or you’re a spreadsheet lover, you can create a Profit and Loss Statement in Excel. It does take more work, but it’s doable. In fact, Bench offers a free Profit and Loss Statement Excel template.
Along with bookkeeping software or an Excel spreadsheet, you might prefer to enlist the help of a bookkeeper or accountant depending on the complexity of your business. While many small businesses can manage their own books and run reports like the P&L on their own, others prefer to have the support of professionals.
If you need referrals to vetted accountants and bookkeepers, let us know!
Keep your business healthy
Having a solid grasp on your P&L ensures you know every month, quarter and year where your business is at financially. With an up-to-date P&L you can easily get the answers you need to make smart business decisions and run a healthy, thriving business.
We’re here to help!
We know most entrepreneurs don’t love accounting and bookkeeping. And sometimes the fear of looking at the real numbers, keeps great entrepreneurs from reaching their potential. We can help! Book a business coaching session with one of our experienced business coaches to get support and resources to work through it all!