If you’re in business for yourself, there’s a good chance you’re familiar with the term “P&L.” Short for Profit and Loss Statement, the P&L is the go-to report for getting a high-level picture of a business’s finances. It churns out the proverbial bottom line: revenue minus expenses. But there’s a little bit more to it than that. In fact, there’s lots to understand in a P&L. So let’s take a deeper dive and learn how to read a P&L statement…
Why is a P&L Statement Important?
First off, an accurate P&L is essential for determining your business’s tax liability. Repeat: an accurate P&L is essential for determining your business’s tax liability. Second, you may be required by law or association membership to keep a P&L statement. Third, you will probably need one for the bank if you want to get a loan. Fourth, an accurate P&L is essential for determining your business’s tax liability. Fifth, and potentially most important, a P&L is basically your guide for business decision-making—without one you’re just fumbling around blindly.
Think of your P&L as a health report card for your business. It shows the results of financial decisions and operations over time and is your best tool for making decisions in the future. So when it comes time to do things like repay a debt, open a second location or hire an employee, a review of your P&L will not only help you make the right decision but also plan for the future.
So How do I Read a P&L Statement?
There are three main sections of a P&L statement; revenues, expenditures and the bottom line. Basically any listed line item on a P&L statement is either a revenue or an expenditure. Under each of those two umbrellas there are a few basic categories…
All the sales that you make
Other payments made to your business. For example, selling old machinery or property, or a tax refund. Those are usually one-time revenue generation events.
Cost of Goods Sold (COGS) – When you sell a shirt for $40, you take in that money under the revenue column, but you don’t “make” $40. Say the cost of the shirt to you at wholesale was $10. That means you made $30 profit and the COGS is $10. In manufacturing, the COGS will be the materials plus the time to produce it and for a service company it will be the man hours devoted.
OPEX – OPEX is short for “operational expenditures” and basically a fancy way of saying “what it takes to run your business in addition to COGS.” OPEX includes things like employee salaries; meals and entertainment; travel and training; office space rental and utilities costs; computer hardware and software; maintenance expenses; marketing communication and advertising expenses; telephone and internet services; insurance costs; external consultant fees… the list, depending on your type of business, goes on and on.
Depreciation – The cost of hard goods like computers, phones, machinery, or a vehicle will be allocated over the length of time that you own the asset. That’s not to say that you don’t have to pay for it up front, but the loss in value each year can be accounted for as a loss to your business come tax time.
Profit – The bottom line (and where they get the phrase “the bottom line is…”) on a P&L statement, is the profit line. Finally, just what you’ve been waiting for! As mentioned, your business’ profit is, at a high level, revenue minus expenses. This is what you really make money-wise and for the most part you can stop right here.
But for those that are now enchanted by the wonderful world of P&L statements, there are actually a few types of profit…
Gross Profit = Revenue – COGS. You will pay for all of your business expenses from salary to rent from this pool of money.
EBIT (Earnings Before Interest & Tax) = Revenue – (COGS + OPEX). Yes, that looks like a scary algebra problem, but it’s simply “what did you sell” minus “how much you paid for your inventory” and “how much it costs to run your business.” It’s sort of the best performance indicator for your business so if you want to know how well you’re really doing, look at this number.
EBITDA (Earnings Before Interest, Tax, Depreciation, & Amortization). Even scarier, right? Don’t worry, this is just EBIT minus your depreciation. Depreciation isn’t truly a cash outflow—you aren’t losing spendable dollars here. While it’s important to track and take the appropriate tax deductions, for P&L purposes EBITDA is just filtering out the remnants of old decisions because it deals just with what you spent on capital expenditures in the past. It really doesn’t have to do with the health of your business’s cash flow today. Depreciation and Amortization are non-cash items, so they really don’t have a great impact on your business’s day to day cash flow health. But, EBITDA is a good way to gauge profitability.
Generating a P&L
Creating a profit and loss statement can be daunting, especially if you’re starting from scratch, using a pen and paper, or a basic spreadsheet. Since the accuracy of the information in your P&L statement is so critical to the success of your business, it’s often best to use accounting software (like Kashoo!) to help you manage it all. (BONUS TIP: The best way to generate a great P&L is to be diligent about capturing your revenues and expenses as you incur them.)
Generating a P&L in Kashoo, either on the web or on the iPad, is a snap. Here’s a quick video that shows you how to rock a P&L (and other reports!) in Kashoo…
And here’s an overview of reports in the Kashoo iPad…
What Should I Watch Out For?
It’s clear that the P&L Statement is a good guide to help business owners manage their business, but it can shed light on even more! Here are a few things you should pay attention to in order to not only avoid problems but also spot them before they cause your business real harm…
- Increasing Sales and Declining Profits – There’s definitely a disconnect here and something is very wrong! Look at your costs. Have they increased? Is there a way to change your margin? Have you grown too quickly? You need to find out what’s going on here.
- Stagnant Sales – Do you need to find a new market? Offer a new product? Increase visibility? Looking for diverse opportunities for growth will safeguard you from putting all your eggs in one basket and then having that basket crash and burn.
- Creeping Overhead – Keep tabs on overhead costs like utilities, salaries and rent and always shop them around on intervals. You may find that you can switch providers or locations and cut those costs without sacrificing revenue.
- Increased COGS – If your cost of goods sold is increasing, find out why. Is it industry-wide or should you review your suppliers? Is it the economy in general? Keeping track of COGS will help keep your revenue healthy.
To determine if your profits are within the appropriate range for your business type and location, you should benchmark to see what the market bears and what you should aim for. Since you rarely have access to competitor information you can do this internally. Compare month to month, quarter to quarter and year to year. This way you will be able to set goals effectively and ensure your business growth over time.
It may take a little time for you to fall in love with managing your P&L statement, but once you do you’ll be obsessed with it—in a good way!
One last thing: Here’s how Kashoo keeps the P&L statement (and other reports!) simple for you, so you can do what you do best: run your business.