Profit & loss statements are one of the simplest ways of getting a financial health check on your organisation. They provide you with a clear, unbiased picture of how you’re managing your finances by stacking up the money coming into your organisation, with the money going out over a period of time. In my experience, it’s shocking just how many organisations are intimidated by the process, or how little value they get out of the process, deeming it a tax-time obligation. Whether you’re a small business or a large corporation, profit and loss statements are essential to ensuring your organisation has enough cash flow to achieve the targets you have set.
While this article is more relevant to small-sized businesses that don’t necessarily have the resources for a full-time accountant role, however, the principles are carried over to any organisation, regardless of size. The U.S. Small Business Association has said that profit and loss statements are the single best tool to find out whether your business is running at a profit or loss, and best of all they’re incredibly simple to compile.
What is a P&L Statement?
A P&L statement, or profit and loss statement, is a statement of income that measures both your organisation’s revenue, as well as your expenses across a certain period of time. This allows you to compare the two numbers, and determine whether your organisation is making, or losing money- your net operating profit or loss figure. They’re vital tools for management to assess their opportunities, or mitigate risks or costly operations that aren’t contributing to the organisation in relation to their consumption of your capital reserves.
When you know your organisation’s net operating profit or losses after calculating revenues and expenses, the management team can make more informed and pointed decisions, and have the data they need to see the results of their changes down the line.
How to Create Your P&L Statement
A P&L statement is different from a simple balance sheet, income statement or statement of operations.
So, what is in a profit and loss statement and how might a business go about creating one?
Here’s what you’ll need to do:
Calculate your organisation’s total revenue
Add up your organisation’s total revenue figure.
Add up your expenses
Calculate your organisation’s expenses, like raw materials.
Determine the cost of goods sold
Subtract the cost of this phase of delivering your goods and/or services.
Calculate Gross Profit
Subtracting the cost of expenses from your revenue gives you the gross profit margin. This figure shows your operating margin, and often shows areas to improve in your organisation’s business or financial modelling.
Factor-in Operating Expenses
Add up your operating expenses, like staff wages, rent and associated expenses, subtract these costs from your revenue figures.
Boom! You’ve created a basic profit and loss statement.
A P&L statement should be undertaken across a number of time frames, so you can get an idea of how your organisation is moving forward financially. We’d encourage you to compile a P&L statement on a monthly, quarterly and annual basis, which gives you an extremely detailed financial picture of your organisation. This is how our organisation calculates what steps we are able to take to grow.
Analysing the data over a time frame like this gives you a clear picture as to whether or not your organisation can afford to hire new staff, or launch a more aggressive and costly growth or marketing strategy, or which areas of your organisation are eating away at your cash reserves.This is essential when calculating how to grow your business
We’ve included a profit and loss template (P&L template) from Services Australia that the government offers to new businesses, sole traders and contractors.
What to do with your P&L statement
Now you’ve created your P&L statement, it’s time to put it to work. The simple act of compiling this data should be an enlightening process and give you a better understanding of where the money flows in your organisation. As we mentioned, ensure you’re running these in a variety of time frames, so you can study trends, and determine whether or not certain strategies are working.
For example, if you’ve launched a new – yet costly – marketing exercise, with a P&L statement you can more accurately determine whether the money the organisation has invested is returning a worthwhile result. In addition, you can study your margins more accurately, and come up with new ways of increasing your profit margin or reducing associated costs in the production of goods and services every month/quarter.
In essence, you’re creating a financial report in order to run a sustainability check on your organisation, which is an essential part of being a proactive, forward-thinking organisation and allowing you to grow your business. Don’t think of P&Ls as a tiresome, tedious and unnecessary process- think of it as one of the simplest yet most effective health checks you can run on your operations.
They will enable your organisation to accurately and honestly determine where the next step in your business journey is and calculate what measures you need to implement in order to get where you want to be.
Thanks for your time, I’ll see you in the next piece.
Kobi Simmat- Director & CEO of the Best Practice Group.