By understanding what your Profit and Loss Statement is telling you, you are better able to understand your business and make the right decisions. Over the many years I have been a bookkeeper I have seen Small Business Owners turn their businesses around, from being a struggling business to a hugely profitable business, mainly due to the fact that they started understanding the Profit and Loss Statement and making decisions around what it was telling them.
Last week we looked at what goes into a profit and loss statement, if you haven’t read that blog yet, please go to – Understanding a Profit & Loss Statement will help you succeed in Business. This week we are looking at what your Profit and Loss Statement tells you exactly.
Why prepare a profit and loss statement?
A profit and loss statement enables you to:
- Answer the question, “how much money am I making, if any?”
- Compare your projected performance with actual performance – you do this by comparing your actual P&L against a Budget P&L
- Compare your performance against industry benchmarks – the ATO have many industry benchmarks. Find yours and compare what your business is doing against others in your industry
- Use past performance trends to form reasonable forecasts for the future – if you look back at what you did this time last year or the last few years, you will be able to forecast pretty accurately what is going to happen at the same time this year.
- Show your business growth and financial health over time – comparing past periods to what you are currently doing is a great motivator if you can see that your sales are growing and so is your profit
- Detect any problems regarding sales, margins and expenses within a reasonable time so adjustments may be made to recoup losses or decrease expenses – by checking your Profit and Loss Statement regularly you are able to identify any issues that come up and make changes quite fast so that you can prevent disaster
- Provide proof of income if you need a loan or mortgage – when applying for finance you will need to supply a profit and loss statement to your financier.
- Calculate your income and expenses when completing and submitting your tax return – your profit and loss statement is an important tool that is used when your accountant is submitting your tax return.
How to Calculate Profit
By using the Profit & Loss Statement you can extract several important figures to explain your business’s profitability.
Gross Profit – Gross Profit is the difference between total sales and the cost of producing the goods or services you sell. Gross Profit = Income – Cost of Goods Sold.
You use the Gross Profit figures to see the overall efficiency of what you are producing and it is the main figure used for setting prices and sales targets. An example is:
Profit and Loss Statement |
|
Local Business |
|
For July 2014 to June 2015 |
|
Sales Revenue | |
Product/Service 1 | 100 |
Product/Service 2 | 1,000 |
Product/Service 3 | 200 |
Product/Service 4 | 2,000 |
Total Sales Revenue [J] | 3,300 |
Cost of Sales | |
Product/Service 1 | 20 |
Product/Service 2 | 300 |
Product/Service 3 | 500 |
Product/Service 4 | 30 |
Total Cost of Sales [K] | 850 |
Gross Profit [L=J-K] | 2,450 |
Gross Profit Margin – The Gross Profit Margin shows you what proportion of gross profit you keep from each dollar of revenue generated. For example, if you have a 20% gross profit margin it means that you keep a gross profit of $0.20 for every $1.00 of income that is generated. Gross Profit Margin = (gross profit / revenue) x 100. Our example below shows that we receive 74c for every dollar that is sold
Profit and Loss Statement |
||
Local Business |
||
For July 2014 to June 2015 |
||
Sales Revenue | ||
Product/Service 1 | 100 | 3.0% |
Product/Service 2 | 1,000 | 30.3% |
Product/Service 3 | 200 | 6.1% |
Product/Service 4 | 2,000 | 60.6% |
Total Sales Revenue [J] | 3,300 | 100.0% |
Cost of Sales | ||
Product/Service 1 | 20 | 0.6% |
Product/Service 2 | 300 | 9.1% |
Product/Service 3 | 500 | 15.2% |
Product/Service 4 | 30 | 0.9% |
Total Cost of Sales [K] | 850 | 25.8% |
Gross Profit [L=J-K] | 2,450 | 74.2% |
Operating Profit – Operating profit is generated from core operations. It does not include expenses from interest or taxes, this is often called Earnings Before Interest and Tax or EBIT. Operating Profit = Gross Profit – Operating Expenses
Profit and Loss Statement |
|
Local Business |
|
For July 2014 to June 2015 |
|
Sales Revenue | |
Product/Service 1 | 100 |
Product/Service 2 | 1,000 |
Product/Service 3 | 200 |
Product/Service 4 | 2,000 |
Total Sales Revenue [J] | 3,300 |
Cost of Sales | |
Product/Service 1 | 20 |
Product/Service 2 | 300 |
Product/Service 3 | 500 |
Product/Service 4 | 30 |
Total Cost of Sales [K] | 850 |
Gross Profit [L=J-K] | 2,450 |
Operating Expenses | |
Sales and Marketing | |
Advertising | 10 |
Direct marketing | 50 |
Other expenses (specify) | 20 |
Other expenses (specify) | |
Total Sales and Marketing Expenses [M] | 80 |
Research and Development | |
Technology licenses | 20 |
Patents | 50 |
Other expenses (specify) | 200 |
Other expenses (specify) | |
Total Research and Development Expenses [N] | 270 |
General and Administrative | |
Wages and salaries | 300 |
Outside services | 20 |
Supplies | 50 |
Meals and entertainment | 20 |
Rent | 100 |
Telephone | 80 |
Utilities | 90 |
Depreciation | 20 |
Insurance | 30 |
Repairs and maintenance | 50 |
Other expenses (specify) | 40 |
Other expenses (specify) | |
Total General and Administrative Expenses [O] | 800 |
Total Operating Expenses [P=M+N+O] | 1,150 |
Operating Profit(Loss) [Q=L-P] | 1,300 |
Net Profit – Net Profit is the total amount earned (or lost) after paying all expenses. It can also be known as ‘the bottom line’. Net Profit = Operating Profit + Other Income – Other Expenses
Profit and Loss Statement |
|
Local Business |
|
For July 2014 to June 2015 |
|
Sales Revenue | |
Product/Service 1 | 100 |
Product/Service 2 | 1,000 |
Product/Service 3 | 200 |
Product/Service 4 | 2,000 |
Total Sales Revenue [J] | 3,300 |
Cost of Sales | |
Product/Service 1 | 20 |
Product/Service 2 | 300 |
Product/Service 3 | 500 |
Product/Service 4 | 30 |
Total Cost of Sales [K] | 850 |
Gross Profit [L=J-K] | 2,450 |
Operating Expenses | |
Sales and Marketing | |
Advertising | 10 |
Direct marketing | 50 |
Other expenses (specify) | 20 |
Other expenses (specify) | |
Total Sales and Marketing Expenses [M] | 80 |
Research and Development | |
Technology licenses | 20 |
Patents | 50 |
Other expenses (specify) | 200 |
Other expenses (specify) | |
Total Research and Development Expenses [N] | 270 |
General and Administrative | |
Wages and salaries | 300 |
Outside services | 20 |
Supplies | 50 |
Meals and entertainment | 20 |
Rent | 100 |
Telephone | 80 |
Utilities | 90 |
Depreciation | 20 |
Insurance | 30 |
Repairs and maintenance | 50 |
Other expenses (specify) | 40 |
Other expenses (specify) | |
Total General and Administrative Expenses [O] | 800 |
Total Operating Expenses [P=M+N+O] | 1,150 |
Operating Profit(Loss) [Q=L-P] | 1,300 |
Other Income [R] | |
Interest Income | 20 |
Profit on Sale of Motor Vehicle | 1,000 |
Rent from Investment Properties | 1,000 |
Total Income [R] | 2,020 |
Other Expenses [S] | |
Interest Expenses | 200 |
Loss on Sale of Motor Vehicle | |
Expenses on Investment Properties | 500 |
Other taxes (specify) | |
Other taxes (specify) | |
Total Taxes [S] | 700 |
Net Profit [T=Q+R-S] | 600 |
Now that you understand how a Profit and Loss Statement works, spend some time going over yours and see how you can improve your business. Leave a comment below if you would like to ask a question, or go to my ASK page and ask me a question there.