Have you ever looked at your profit and loss statement and wondered what all of it means? Is it something just for accountants? Understanding your profit and loss statement (P&L) can give you clarity on your businesses financial health.
What is a profit and loss statement (P&L)?
A profit and loss statement is a financial report that shows how much your business has spent and earned over a specified time.It also shows you if you’ve made a profit or a loss over that time, hence the name! The profit and loss statement is also shortened to P&L.
The P&L statement will summarise all the activity recorded in your income and expenses, over a period of time. Income typically includes sales while your expenses will cover things like payroll, advertising, rent and insurance. The statement will include credit sales that your customers might not have paid yet. It will also include bills for expenses that may not have been paid.
Your total profit or loss is what you’ve earned minus what you’ve spent. If the amount is positive, it’s called a net income. If it’s negative it’s called a net loss.
A P&L statement can also help you calculate profit margins, showing you how good your business is at converting revenue into profits.
Some of the terms used in a P&L
Revenue/income – the money that you’re bringing in. This is income generated from the sales of goods and services related to your business. This is a critical number in your P&L as it’s what’s needed to cover your expenses. Your expenses need to stay lower than your revenue/income in order to make a profit.
Direct costs – These are costs that you incur when you make your products or deliver your services. For example, if you’re a toy shop, the direct costs of every sale is what the shop paid to buy the toys from the manufacturer. For the toy manufacturer, the direct cost would include materials used to make the toys. However, if you’re a consultant, you may have little or even no direct costs.
Gross margin – This tells you how much money you have left over to cover your expenses. This is after you have covered the cost of the product or service you are selling. If you subtract your direct costs from your revenue, it will provide you with your gross margin.
Operating expenses – this will cover all of your expenses that you incur to keep your business doors open, but excludes your direct costs. This means things like your rent, business rates, utilities, wages and marketing expenses.
Operating income – This is earnings before interest and taxes. It’s a way to measure a business’s profit that includes all income and expenses, except interest and income tax expenses.
Depreciation – These are special expenses that are associated with assets that your business owns. Over time, assets like vehicles orlarge pieces of equipment lose their value or depreciate. You’ll expense that decline in value in the depreciation section of your P&L.
Net profit – this is also known as net income or net earnings. This is your business income minus all of your expenses. Basically, what you’re left with after everything is paid.
The profit and loss statement for your business is a valuable tool. It’s key to evaluating your business performance. So, understanding your profit and loss statement (P&L) is vital in growing your business and keeping on track.
If you would like help understanding your P&L give us a call/email and we’d be happy to go through it with you.