Whether you are a veteran company owner or a start-up entrepreneur, one of the most outstanding instruments in your hands is your profit and loss statement. With this statement regularly updated and on hand, you have a straightforward breakdown of your company’s costs and revenue, enabling you to make informed decisions for potential performance regarding hiring, expenditure, and development. Due to the emphasis on a specific booking period in each declaration, multiple P&L reports from prior periods can be compared to see whether its profitability is growing or declining over time.
The Basic Concept Behind Profit and Loss Statements
The profit and loss statement is accounting documentation summarising the revenue, costs, and expenditures of a business entity for a particular period. A variety of names can be used for the profit and loss statement, such as P&L, revenue statement, profit and income statement, operative statement, sales statement, and financial results report.
It summarises the profits (net sales) of the business minus the costs and expenditures (i.e., the cost of goods) incurred during a given operating period.
In other words, profit and loss are measured over time (income - cost = profit). A P&L statement is an essential indicator of assets & liabilities, similar to a balance sheet. But, in most cases, the balance sheet is an indicator of activity.
The Necessity to Comprehend a Profit & Loss Statement
A statement of profit and loss indicates how much the company has to sell and market the stock or the services for profit. As you know, to thrive and expand, a business needs to make a profit. If you evaluate a statement of profit and loss, you will assess your business’s cash flow that is available to repay current debt, fund new debt such as loans to grow the company or reinvest in the business.
Think of the accounting team as a personal financial interpreter; use your experience and know-how to gather and present the company’s raw financial information more straightforwardly. While you can leave the data processing to those who do best, reading and interpreting the statement of P&L is not only a duty of your accounting department; you must make decisions as a leader.
Analysing Profit and Loss Statements
A competent financial analyst’s essential duties are evaluating a company’s profit and loss statement to make decisions about the company’s financial power and future directions.
Each time your accounting team submits a profit and loss statement, they help you to understand critical aspects of the sustainability of your business. The financial performance of your business is measured by the profit and loss statement. Usually, your business’ sustainability, a profit and loss statement is produced for one month, quarterly, or a year.
While the variety of data in the P&L statement overwhelms many business owners and managers, it is important to interpret this information for informed business decisions. The good news is that you don’t have to learn how to decode the financial details, but you can read your P&L statement and use the basics mentioned here to guide your company without your professional accounting team’s help.
You can find several accounting terms in the profit and loss statement, but when you have a basic idea about them and how they affect your business, they are not hard to interpret. We have separated each part of the P&L statement to help you understand what the individual elements mean to your business.
1. Revenue
Revenue is also referred to as the top line since it is the first line to see your declaration of profit and loss. The amount of all sales is income, which serves as the basis of the entire ledger.
2. Cost of goods sold
The costs of producing your company’s products or services are reflected in the costs of the goods sold. These costs range from production to raw materials’ costs. As a concept, COGS needs to be identified and followed up by the business owner and leader. Sufficient knowledge must be acquired about COGS to understand the principal aspects of your P&L statement.
3. Gross profit
Once you understand the revenue and cost of goods sold, you can measure your company’s gross profit. Total revenue minus cost of goods sold is equal to gross profit. The gross profit is also referred to by an operating margin in the world of business.
4. Selling, general and administrative expenses
The costs of promotion, distribution, and delivery of products and services in a corporation and the costs to operate the company as a whole, are represented by the sale, general and administrative expenses. All benefits are given to the company’s employees other than the labour costs in this expense field. This field also includes office costs, expenses for travel, and entertainment; in short, any expenses other than the cost of goods sold.
5. Earnings before interest and tax
Before taking account of the financial burden or the way the company is financed, EBIT reflects its successful output. The following formula measures EBIT, also known as operating income: Gross profit - total OPEX = EBIT.
6. Earnings before interest, tax, depreciation, & amortisation
To better understand current results, this estimate of EBITDA needs to be measured, which takes EBIT and depreciation and amortisation variables into consideration. As a metric for cash flow and profit generated from a company’s current assets and operations, owners or investors use EBITDA.
7. Net earnings
At the bottom of your P&L statement, you will see net profits, aptly called your bottom line. Net earnings can also be called net profits, which represent your company’s profit. Once all sources of income, expenditures, interest, and tax are taken into account, this grand sum reflects your company’s real income. This sum is divided as retained earnings by shareholders or added back into the business depending on its structure.
How to Create a Profit and Loss Statement?
We appreciate that you are passionate about your company and want to interpret your profit and loss statement. We hope that these simple steps can help you understand how to prepare and interpret a statement of profit and loss:
1. For a specific operating period, like a fiscal year, you need to calculate your net income. For instance, for a particular date, list all your earnings minus any discounts.
2. Second, measure the cost of goods sold in case you are in a manufacturing business. But calculate the costing if you’re a service provider. This involves accounting heads directly associated with the production process like manpower and overhead. Labor and Overhead would be the major cost factors for a service provider, but certainly not for a manufacturing business.
3. Calculate the net sale by subtracting the COGS from the revenue of your company.
4. Next, deduct operating costs such as leases, marketing expenses, bad debts, wages not specifically related to product production, and other operating expenses from the net sales.
5. You’re left with profits before interest, taxation, depreciation, and amortisation after operating expenses are deducted (EBITDA). EBITDA is deducted from depreciation and, where appropriate, amortisation, leaving earnings before interest and taxes (EBIT), often known as operating profit.
6. Once interest payments and all other costs are exempt from operating profit, it leaves you with earnings before taxes.
7. Next, income taxes need to be deducted from EBT to find out the net profit.
8. Finally, after all costs, you will be left with your business’s net profit.
Final Words
Any company’s primary goal is to raise its revenues profitably. The best way to verify a company’s progress is to read its P&L document. A simple analysis of P&L would show the growth in sales and the profitability of the company. Strong, sustainable companies show continuity in their P&L statements concerning different income and expenditure heads. Spikes in sales and costs should be evaluated to verify whether these are one-off incidents or whether they represent the underlying shift in the market conditions.
Also read:
1) Business Success Tips Every Business Owner Should Know
2) Top 10 Businessmen in the Industry & What You Can Learn From Them
3) Tips for Work-Life Balance for the Modern Businessperson
4) How to get your business listed on the Stock Exchange?
FAQs
Q. What are the operating expenses in a business?
Ans. The expenses which are over and above the procurement of materials like sales commission, packaging expenditures, transportation costs are known as operating expenses.
Q. What are interest expenses?
Ans. The expenses incurred for the payment of various loans and credits are known as interest expenses.
Q. Which types of income are known as other income?
Ans. Any income that comes from outside the main product/service sales is known as other income. For example, if a company sells its unused assets, then the proceedings are known as other income.