By Denis Jakuc
Your company’s profit and loss statement (P&L) shows the financial strength and earning power of your company over time. It’s the one statement that delivers a clear picture of whether your company’s operations are resulting in a profit or a loss after accounting for all the expenditures.
The P&L is an excellent financial tool for measuring performance over any timeframe. P&Ls are typically done quarterly and annually, but you can run a P&L report weekly or even daily. Shorter time frames allow the P&L to function as an early warning system for problems. This lets you spot them when they’re more manageable, giving you more time to correct them. The simple P&L is truly a valuable “business” diagnostic tool. Much like the readings of an airplane Dashboard you can use the P&L to really guide and manage your overall business, segments of the business, and products & services within your business.
A Tool for Decision-making
The P&L is also a very useful tool for looking at the performance of any part of your business, down to individual products or services. This makes the P&L a very useful decision-making tool. It helps you decide which businesses you should invest more in—and which should get less of your attention—based on the net profit they’re contributing. For example, a product may have a big gross profit (sales revenue minus cost of goods sold). However, when you deduct sales expenses, the net profit margin may become really small. A P&L on that product will reveal this problem.
Of course, profit isn’t the only reason to keep a product or service in your arsenal. For example, you may maintain a less profitable offering because it rounds out your product line capabilities, or allows you to provide customers with the convenience of one-stop shopping. You should still do P&Ls for individual products and services so that you know how each part of your business contributes to your bottom line.
A Tool for Tax Prep and Funding
In addition to helping your make decisions about your operations, your P&L can help you arrive at the figures required for filing statutory tax returns. The net income number on the annual P&L statement is the base for calculating how much tax the business will have to pay for that year. Finally, P&Ls from a few recent years are required when borrowing funds from a financial institution, or when looking to raise capital from investors. Several annual P&Ls help lenders and investors gauge the earning potential and steadiness of your business. This then helps them decide on the amount of money to loan or invest. Of course, if your business is brand-new, it won’t have these prior-year P&Ls. Therefore, you’ll have to prepare a pro forma, or forecasted, P&L, covering a few years into the future. Lenders and investors may also ask you for other statements and documents.
The Structure of the P&L
The P&L statement includes:
- Sales or Revenue. All Sales over the measured time period, both cash and accounts receivable. Any discounts, product returns, or allowances given, must be subtracted from Sales.
- Cost of Goods Sold. This covers the direct costs incurred in producing what you sell—the materials, labor, and overhead costs that are directly used to produce a product or service. The indirect costs of delivering a product or service, such as your selling and marketing expenses, are not counted here.
- Gross Profit or Margin. This figure is arrived at by subtracting the Cost of Goods Sold from total Sales.
- Selling, General and Administrative Expenses. Selling Expenses include: the salaries, commissions, and bonuses of sales personnel; marketing costs, including advertising and publicity; shipping and transportation charges; and any other costs associated with selling your product or service. General and Administrative Expenses cover the indirect expenses of running office, factory, and warehouse facilities. These include the cost of: staff salaries, rents, phone and utility bills, IT services, office supplies, maintenance and repairs, legal fees, insurance, fees for statutory compliances, and any other overhead costs. These expenses are then deducted from your Gross Profit.
- Depreciation and Amortization Costs. Depreciation is the decrease in value of a physical asset because of its usage (wear and tear) over time. Amortization is the lowering of the book value of a loan or other intangible asset over a set period of time. Both of these non-cash expenditures are then deducted from Gross Profit.
- Interest Income and Expenses. Interest Income earned from deposits or other holdings are added to Gross Profit. Interest Expenses paid on loans and other forms of borrowing are deducted from Gross Profit.
- Taxes. Current and deferred tax liabilities are deducted from Gross Profit.
- Net Income. This is the final figure the P&L arrives at. It’s either a positive number, a Profit, or a negative one, a Loss.
Additional P&L Insights
Reviewing P&Ls can tell you a lot about how your company is doing financially, and where it can improve its profitability. In addition, comparing different annual P&L statements will tell you how your business is progressing over time. You can also compare your P&L with industry benchmarks, or with the P&Ls of other players in the industry, if available. This will help you assess your position in the marketplace.
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InnovatorsLINK Business Writer and Brand Strategist
A business writer his entire career and successful businessman. He was a partner in a top-10 Boston ad agency, a senior level executive at Young & Rubicam NY and Interpublic Group, and, since 2003, an independent consultant for companies from startups to global leaders, positioning their brands and writing all forms of content to promote their growth.