Understanding a profit and loss statement will help you succeed in business. I know this sounds a bit far fetched, but it happens to be true. I have been bookkeeping for nearly 20 years and every time I have a client decide to look over the profit and loss statement with me and to ask questions and to understand it their business starts to turn around. They then realise how to make effective changes within their business and therefore their business starts to thrive even more than it was before.
Over the next two weeks we will be taking a look at what makes up a profit and loss and how to read it effectively so that you can understand it more effectively and start to turn your business around.
What is a profit and loss statement?
A profit and loss statement is also known as an income statement. It lists your sales and expenses and is recorded either on a monthly, quarterly or yearly basis. It reflects the past performance of the business and is a report most often used by small business owners to track how their business is performing.
This report measures the profit or loss that a business is making. It can help you develop sales targets and appropriate sales prices for goods/services using various tools to help.
What is in a Profit and Loss?
Another name for a Profit and Loss Statement is an Income Statement, Revenue Statement, Statement of Financial Performance, Earnings Statement, Operating Statement or Statement of Operations.
The Profit & Loss Statement has 2 different sections that represent the accounting equation: Income – Expenses = Profit (or loss)
Income – all of your income from your primary business activities are included here – Sales of Products or Services. Also any income from your secondary activities – Bank Interest – and any other financial gains.
Expenses – all of your business expenses from your primary activities – materials and labour costs. Also any expenses from secondary expenditure – bank fees – and any other losses during the period.
Revenue (Income) is the amount of money that the company actually earns during a specific period. This includes discounts and deductions for returned merchandise. You can have Operating Revenue (income) and Non-Operating Revenue (Income).
Operating Revenue is typically earnings before interest and taxes. It is earned from the sale of goods and services specifically related to the business.
Your Chart of Accounts can look like pretty much whatever you want it to, the more detailed it is the better reports you get from your accounting program. Following is an example of what it could look like.
42000 Miscellaneous Income
Non-Operating Revenue is gains from sources not related to the typical activities of the company. It can include gains from investments, sales of property or assets.
Your Non-Operating Income in your Chart of Accounts will look something like this:
81000 Other Income
81100 Interest Income
81200 Trade in on Motor Vehicle
81300 Rent Received from Investment Property
Expenses are the amounts paid or incurred for the purpose of earning revenue, such as paying wages or repairs to a vehicle, which may be used in the business.
Expenses can be broken down into Cost of Goods Sold, Operating Expenses and Non Operating Expenses.
Cost of Goods Sold are the direct costs incurred in the production of the Goods Sold by the business. This includes the cost of the materials used in creating goods along with the direct labour costs used to produce the goods.
As with the income, the more detailed your Cost of Goods Sold is the better reports you will get. Your Chart of Accounts could look like this:
Cost of Goods Sold
51000 Purchases for Resale
Operating Expenses are expenses incurred in the carrying out of the businesses day-to-day activities; they are not directly associated with the production of goods or services.
Once again, the more detailed your expenses are in your Chart of Accounts the better reports you will get. Your Chart of Accounts can look like this:
61000 General and Administrative
61110 Accounting Fees
61130 Bank Charges
61140 Bookkeeping Fees
61145 Client Gifts
61150 Computer Repairs/Supplies
61160 Depreciation Expenses
61170 Expensed Equipment
61190 Legal Fees
61200 Meeting Expenses
61210 Office Supplies
62000 Communication Expense
62130 Mobile telephone
63000 Motor Vehicle Expenses
63100 MV – Expense – Vehicle 1 (AAA-111)
63110 MV 1 (AAA-111) – Depreciation
63120 MV 1 (AAA-111) – Fuel
63130 MV 1 (AAA-111) – Parking & Tolls
63140 MV 1 (AAA-111) – Registration & Insurance
63150 MV 1 (AAA-111) – Service & Repairs
63200 MV – Expense – Vehicle 2 (ZZZ-222)
63210 MV 2 (ZZZ-222) – Depreciation
63220 MV 2 (ZZZ-222) – Fuel
63230 MV 2 (ZZZ-222) – Parking & Tolls
63240 MV 2 (ZZZ-222) – Registration & Insurance
63240 MV 2 (ZZZ-222) – Service & Repairs
64000 Occupancy Expenses
64130 Property Insurance
64140 Property Taxes
64170 Water Rates
66000 Payroll Expenses
66110 Fringe Benefits Tax
66120 Staff Amenities
66130 Staff Recruitment
66140 Staff Training
66150 Superannuation Expense
66160 Wages & Salaries
66170 Workers’ Compensation
66180 Other Employer Expenses
Non Operating Expenses are expenses incurred by activities not relating to the core operations of the business. They can include interest charges or borrowing costs.
Your Chart of Accounts may look like the following:
91000 Interest Expense
92000 Loss on Sale of Motor Vehicle
93000 Investment Property Expenses
99999 Client to Advise
We use Client to Advise for items we are unsure of. We then take the list to the owner of the business and ask them where to allocate these expenses.
Over the next week, have a look closely are where you are allocating your income and expenses in your accounting program. Are they going to the right place? Make sure that when you get to do a Profit and Loss Statement it is able to tell you the correct ‘story’. Next week we will look at how to calculate Profit (Loss) and why we need to.