5 Areas of a Profit & Loss Statement and How to Read Them
If you have been filing away your Profit and Loss Statements without reading them, you are not alone. We encounter many business owners who do the same. But, it is essential to read and understand your Profit and Loss Statements if you really want to run your business successfully.
As a business owner, you need a good picture of the financial health of your business at all times. Your Profit and Loss Statement is a good indicator of the financial status of your company. If financials are not your forte, you might not understand the importance of your Profit and Loss Statement – or understand how to read it.
Keeping Score of your Financials
Think of it like this, when watching or playing sport, we know how our team is doing by checking the score. Throughout the game, the score is kept and at the end, the final score tells us how we fared against the other team. Your Profit and Loss Statement is how you keep score in your business!
The Profit and Loss Statement is one of the most important pieces of bookkeeping with which you should be familiar. For one, it is one of the primary documents that you will need to provide if you want to acquire financing. It shows banks and investors your company’s income, debt load and overall stability.
Secondly, it tells you if your business is profitable. It is astonishing just how many small businesses really have no idea if they are making a profit or not. If they are making sales, everything is good right? Well no, not exactly….
If you are only looking at revenue to determine how your business is doing, you do not have an accurate or realistic picture of what’s actually going on in your business. Revenue or income is just one of the items on the Profit and Loss Statement. That is before everything else, such as the cost of goods sold and fixed or operational expenses have been deducted.
Thirdly, many companies are required by law or association membership to complete Profit and Loss Statements. Your Profit and Loss Statement can cover a week, a month, a quarter or a year. Ideally, you should be looking at your Profit and Loss Statements for your business on a weekly and monthly basis to truly keep track and control what’s happening in your business. Weekly, for businesses who have high frequency, high volume transactions such as bakeries and Monthly for businesses who have low frequency, low volume transactions, such as builders or tradies.
So what are the five areas of a Profit and Loss Statement?
Revenue or income is what you are bringing in from the sales of your products or services. Revenue is obviously critically important because it is the money you have available to cover your expenses. If your revenue is low, then you will need to lower your expenses to stay profitable or make a plan to increase your sales to ensure that you on track to achieving your goals for the month and quarter.
2. Cost of Goods Sold
These are the costs that you have incurred to buy, make or deliver your products and services. There are various direct costs associated with selling every product, from bicycles to sandwiches and milkshakes. You need to account for these costs for a true reflection of what it costs you to actually sell your products.
In a service business, this is often called the Cost of Service. If you are in a services industry such as a photographer or a consultant, your Cost of Service could include any expenses associated with providing your services such as your time, printing, travel, accommodation and photocopying costs.
3. Gross Profit
Your Gross Profit is what you have left after you have deducted your Cost of Goods Sold from your Revenue. This is what you have available to run the rest of your business. When you have a high gross profit, it means that it costs you very little to deliver your product or service and you have a healthy supply of money from every sale to cover your other expenses not associated with your product or service. The Gross Profit percentage represents this number as a percentage. The higher the percentage the better!
4. Fixed Expenses
Your Fixed or Operational expenses are the additional costs you have to pay every month. This is what it costs you to stay open, before you have produced or sold anything. Here, we are talking about rent, leases, wages, insurances, marketing and utilities.
5. Net Profit
Your Net Profit is the final amount that you have left once you have covered the cost of producing and selling your products or services, as well as the operational expenses incurred simply to stay open. This is your bottom line. It is the amount of money you actually made. This is your profit!
It’s your vantage point
Your Profit and Loss Statement gives you the bigger picture of the true costs of running your business and the money you have actually made. It will also provide you with very important information to guide decision making and set goals. Check your Profit and Loss Statements regularly – it will help you keep score!
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