The profit and loss report is a useful tool for monitoring business activity for business owners, as it highlights whether and where their business is succeeding and where it is struggling. Investors use profit and loss reports to gauge the financial health of a potential investment, and use it to calculate what kind of return (profit) they are getting on an existing investment.
What makes up the Profit & Loss Statement?
In general, your profit and loss report will be split into 3 sections:
- Revenue/sales – details of all income from primary business activities (sale of products and services), as well any revenue from secondary activities (e.g. bank interest) and any other financial sources
- Cost of sales – if selling product, the cost of that product, before any shop or warehouse costs
- Expenses – details of all expenditure on primary business activities (e.g. premises costs (overheads), labour costs), any secondary expenditure and any other losses during the period.
The top part of the revenue section of your profit and loss report is total sales. Secondary revenue and other income can be unpredictable, so to grow the business you should focus on your primary sales revenue.
Look at how much sales have risen or fallen since your previous profit and loss report. Then by breaking sales figures down into individual products or product lines will help you see which products are performing well and which products need attention.
Aim to increase revenue in the period between each profit and loss report. A pattern of falling revenue shows a business in trouble.
Cost of Sales
Keep an eye on the cost of goods sold (COGS) – these are the cost of product, or of your manufacture, the direct labour and any raw materials used to produce your goods or services. Also watch if suppliers are pushing prices up – try to use your good credit history of paying them, to negotiate a delay in price rise, or a slightly better price for your loyalty – most businesses will be open to negotiate!
Also don’t ignore early payment discounts – eg pay earlier or on-time – it can all add up!
These are the operating expenses (i.e. cost of indirect labour (office staff etc) and any other costs not directly linked to the production of product or services).
Again be on the look-out to reduce costs wherever possible. A rising figure for material costs could mean you need to find a different supplier, or find more efficient ways to produce your products. Inflation is another factor likely to cause costs to increase across a market over a period of time, so some increase will be inevitable.
The operating costs can be harder to bring down. For example, if rent increases it may not be practical to move to cheaper premises, or the move itself may cost more than the increase in rent. Labour costs can also be complicated, as you cannot usually bring down your wage bill without reducing the number of employees (which may not be possible or desirable) and will usually affect the business flow. Also check your profit and loss report for any sudden or unexpected spikes in costs, rather than gradual increases over time (due to factors such as inflation and annual employee pay rises).
Key Parts of the P&L Statement
From the profit and loss report, look for these of important figures to explain your business’s profitability and also COMPARE them to the last reporting period:
- Gross profit = revenue – cost of goods sold This is the difference between total sales and the cost of producing the goods or services you sell. It is an indicator of overall production efficiency and a key figure for setting prices and sales targets.
- Gross profit margin (%) = (gross profit ÷ revenue) x 100 Shows what proportion of gross profit you keep from each dollar of revenue generated (e.g. 60% gross profit margin means you keep a gross profit of $0.60 for every $1.00 of revenue generated).
- Operating profit = gross profit – operating expenses This is the profit generated after overheads. It does not include expenses from interest or taxes (often called ‘earnings before interest and tax’ or EBIT).
- Net profit = operating profit – (taxes + interest) Also known as the ‘bottom line’, net profit is the total amount earned (or lost) after paying all expenses including interest and tax.
For more on Profit Margins, see:
- Business Financials 101 – Business Health Ratios – The Profit and Loss Statement and Profit Margins
- Cashflow Tips – Making Profit does not mean you have CASH! Know the difference!
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