Many business owners don’t focus on their financials because they don’t know what they are telling them. But to feel more confident in running your business, it is important to understand your profit and loss statement (P&L) statement.
It is a useful tool for monitoring your company’s financial standing as it gives you a clear picture of costs and revenues. Hence, we’re going to give you the rundown on understanding the basics of a P&L.
Every P&L follows the same simple formula:
Revenues – Costs of Goods Sold – Expenses = Net Income or Loss
Now that you know the four basic components, you can use a P&L to:
Focus on Margin
Tracking your sales by margin will help you see which products are performing well and which products need attention. It is very important to know how much money you make by selling services or goods. To calculate your gross margin you would take your revenues minus your cost of goods sold = gross profit margin. To convert that to a percentage you would divide your gross margin by your total revenue.
Understand Fixed Cost
Your fixed costs are necessary expenses you need in order for your business to operate, and it will stay the same regardless of how much or how little you sell. These are typically in the "expense" section of your P&L.
Know Your Breakeven
By reviewing your P&L regularly, you will be able to evaluate what it takes to operate your business each month. This is your breakeven. Breakeven is when the revenues minus the cost of goods sold and expenses equals $0. Naturally you should shoot for revenues to exceed costs of goods sold and expenses to generate a profit.
Of course, you should look to reduce costs wherever possible. Specifically evaluating each line item in the expense section of your P&L will help you identify areas of wasteful spending. Think recurring charges for subscriptions you do not use, advertising that is not generating leads, unnecessary late charges, etc. Sometimes the best way to increase profit is by decreasing expenses.
Never Forget Cashflow
The P&L only tells half the story. Cash Flow is the lifeblood to any small business. Making sure you stay on top of collections and stretch vendor terms can be a full-time job. Make sure you are taking advantage of all vendor prompt pay discounts and sending reminders to customers when their bill is due.
Next time we will break down the Balance Sheet so you can better understand how these reports tell a story about your business.
Need help in preparing your profit and loss statement? Our team of experts here at Allison L. Reynolds, CPA, PLLC can assure that if your financial reports are accurate, that will help you make a better decision. Give us a call now at (615) 823-3480 or you can book a FREE consultation with us here!