How to understand – and use – a profit & loss statement
It is probably safe to say two things about you, the small business owner:
First, I bet you went into business for yourself out of love. Either you loved doing something so much that you wanted to do it every day your way, or you loved the idea of being your own boss so much that it was worthwhile to take the risk, leave the job, and venture off on your own. Either way, it was the love of something that compelled you forward.
Second, it is probably also safe to say that you didn’t become an entrepreneur because you loved accounting (unless, of course, you are an accountant).
Even so, there are basic accounting and financial analysis tools that you should learn if you want to stay in business for the long haul. One of them is the Profit & Loss Statement, also known as a P&L. Despite sometimes looking imposing, a P&L is really just a basic math equation of your business:
Sales – Costs = Profit
See, that wasn’t so bad.
Now, if you have ever looked at the P&L your accountant or CFO created for you, it likely looks a lot more complicated than that, with sub-categories for sales and costs and what not, but really it just boils down to that simple equation above.
Analyzing your P&L
At the top of your P&L will be your sales number (this may also be called “income” or “revenue”). The sales number is usually broken down into a variety of categories, depending upon your business and profit centers.
This is where the value of a P&L can really be seen. The P&L is a snapshot of all of your work, boiled down to its essence. Did that marketing plan for the new store work? Look at the sales numbers for the new store and see. Your P&L can tell you which products, services, and revenue streams are paying off and which are lagging. It allows you to make smart decisions about your business.
Indeed, if you are wont to do an 80-20 analysis, your P&L will really come in handy. Which of your profit centers is generating the most income for your business? Your P&L will tell you. It will also tell you which strategy may not be worth the effort you are putting into it.
Next will be your expenses: Again, when looking at your P&L you will see a variety of categories for your different expenses. For example:
Marketing and Advertising
Taxes and Insurance
Again, the magic here is that the P&L gives you a birds-eye view of where your business really is, as opposed to where you think it is. While you may have an intuition – and even some facts – that your labor costs are too high, your P&L knows for sure.
One jargonesque phrase you may see in your P&L is COGS or COS. COGS stands for Cost of Goods Sold, and applies to product-based businesses. It is the actual cost for producing and selling that product. COS if the same thing for a service business – the costs related to providing your service (as opposed to general overhead for the business.) The equation here is:
Sales – COGS = Gross Profit
This is your overall revenue. After that, your P&L will subtract other costs. The final equation at the bottom of your P&L then is:
Gross Profit – Other Expenses = Net Profit
This is how much money your business actually makes.
Do you see how valuable this information is? Your P&L tells you exactly what is working and what isn’t. It explains, in a few short lines, which efforts can safely be doubled-down on and which need to be refined. The numbers don’t lie.
If you still need assistance with your bookkeeping needs or have other accounting questions, please call Tony Silva at (619) 477-4357 for a free consultation.