Any small business owner needs to understand at least the fundamentals of their finances, and although a Bookkeeper can be of great help, it is important that you understand what all of those oh so helpful reports are telling you.
Today, I’m going to go over the Profit and Loss (P&L) Statement, and how this can help you understand the state of your business.
The P&L Statement measures your income, costs and expenses over a set period of time (often a year, quarter, or month). Reviewing your P&L statement over the course of several months can give you a pretty good idea as to how your business is faring. It will also help you to identify (in real numbers) any seasonal patterns or trends.
Gross Earnings: The first line of the P&L is “Sales” (product sold) or “Revenue” (services rendered). This is the “top line”, and refers to the sum of all sales or revenue earned during the period. Depending on the detail of the report, you may find that this is broken down further into types of sales or revenue, depending on the variety of your sources of income.
From your total revenue, we need to subtract all of the costs to run your business, which will leave us with our “bottom line” or “Net Earnings”. There are several different kinds of costs that need to be accounted for to determine your net earnings.
Cost of Goods Sold (COGS): If you sell a product, you will have to first purchase the raw materials or prepared product for your inventory.
Depreciation: Investments that the company has made will lose value over time. For example, if you purchase a company car for $28,000, over the course of 5 years it may only be worth $6,000. This loss in value is calculated regularly to reflect the current estimated value of assets.
Operational Expenses: Operational expenses primarily reflect the cost of salaries for staff, debt, and regular bills. Essentially, the day to day cost of doing business.
Financial Costs: These are usually related to interest on loans, late payment fines, interest on credit cards, bank accounts, exchange costs/gains etc.
Extraordinary Costs/Gains: Sometimes, there are just strange, non-recurring costs or revenues that don’t really fit anywhere else. It’s a good idea to make sure that if there are any extraordinary costs or gains, you know where they came from.
Gross Profit: Revenue – COGS = Gross Profit This numbers is helpful to know just how much money your company is bringing in every period. This is what you have to pay your bills.
Earnings before interest and tax (EBIT): Gross profit – Operational expenses = EBIT. This is a helpful performance indicator as to how your company is doing.
Net Earnings: Your “bottom line”. The end result of all Revenue – all Costs, including interest and tax. This is what your company really brought in during the period. Hopefully, this number is positive and meeting your goals. If not, you’re potentially in trouble, and need to find out how to either increase your revenues, or cut your costs. This value can either be retained within the company, or paid out to shareholders.
For small businesses, I recommend that the P&L report be reviewed regularly. As previously mentioned, it can help identify trends, seasonal patterns, as well as warn you of impending danger. If you don’t already receive this report from your bookkeeper or accountant, I highly recommend that you ask them for it as part of your regular monthly financial reports, and of course, don’t be afraid to ask questions.