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Business Financials – The Profit and Loss Statement for Business and how it works
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Published on Thursday, 01 June 2017 10:28
The profit and loss (P&L) statement, is also known as an income statement (mainly USA), which shows the profitability of a business over a specific period and is usually produced monthly, but can also be raised quarterly or annually.
The profit and loss report is a for monitoring business activity for business owners, as it shows whether the business is succeeding and also where it is struggling. Investors use profit and loss reports to gauge the financial health of a potential investment, and use it to calculate what kind of return (profit) they are getting on an existing investment.
What makes up the Profit & Loss Statement?
In general, your profit and loss report has 3 sections:
- Revenue/sales - details of all income from primary business activities (sale of products and services), as well any revenue from secondary activities (e.g. bank interest) and any other financial sources
- Cost of sales – if selling product, the cost of that product, before any shop or warehouse costs
- Expenses - details of all expenditure on primary business activities (e.g. premises costs (overheads), labour costs), any secondary expenditure and any other losses during the period.
Here is how it looks –
Revenue/Sales
The top part of the profit and loss report is total sales or revenue. Secondary revenue and other income can be unpredictable, so to grow the business you should focus on your primary sales revenue.
Look at how much sales have risen or fallen since your previous profit and loss report. Then breaking sales figures down into individual products or product lines will help you see which products are performing well and which products need attention.
Aim to increase revenue in the period between each profit and loss report. A pattern of falling revenue shows a business in trouble.
Cost of Sales
Keep an eye on the cost of goods sold (COGS) or simply Cost of Sales – these are the cost of product, or if you manufacture, the direct labour and any raw materials used to produce your goods or services. Also watch for suppliers pushing prices up - try to use your good credit history of paying them, to negotiate a delay in price rise, or request a slightly better price for your loyalty – most businesses will be open to negotiate! Also don’t ignore early payment discounts – eg pay earlier or on-time – it can all add up!
Expenses
These are the operating expenses. These are the overheads, rent, power, cleaning, insurance and include costs of indirect labour (office staff, etc) and any other costs not directly linked to the production of product or services. Mainly, all the fixed costs to have premises open and running.
Be on the look-out to reduce expenses wherever possible. A rising figure for material costs could mean you need to find a different supplier, or find more efficient ways to produce your products. Inflation is another factor likely to cause costs to increase across a market over a period of time, so some increase will be inevitable.
The operating expenses can be harder to bring down. For example, if rent increases it may not be practical to move to cheaper premises, or the move itself may cost more than the increase in rent. Labour costs can also be complicated, as you cannot usually bring down your wage bill without reducing the number of employees (which may not be possible or desirable) and will usually affect the business flow. Also check your profit and loss report for any sudden or unexpected spikes in costs, as well as gradual increases over time (due to factors such as inflation and annual employee pay rises).
Key parts of the P&L Statement
From the profit and loss report, look for these important sections to explain your business's profitability and also COMPARE them to the last reporting period:
- Gross profit = revenue – cost of goods sold
This is the difference between total sales and the cost of producing the goods or services you sell. It is an indicator of overall production efficiency and a key figure for setting prices and sales targets;
- Gross profit margin (%) = (gross profit ÷ revenue) x 100
Shows what proportion of gross profit you keep from each dollar of revenue generated (eg. 60% gross profit margin means you keep a gross profit of $0.60 for every $1.00 of revenue generated);
- Operating profit = gross profit – operating expenses
This is the profit generated after overheads. It does not include expenses from interest or taxes (often called 'earnings before interest and tax' or EBIT);
- Net profit = operating profit – (taxes + interest)
Also known as the 'bottom line', net profit is the total amount earned (or lost) after paying all expenses including interest and tax.
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