Do the numbers behind your business have your head spinning? When you’re a business owner, you don’t always have the background to keep complex numbers and accounting systems straight. You went into business to work out your ideas, not necessarily your finances.
So, when your profit and loss statements come across your desk, what do you do with them? Do you decipher the numbers and what they mean for your company? Or, do you skim through it and move on with your day? These statements hold important information that helps you make informed decisions about the future of your business.
The Importance Of Profit And Loss
To fully appreciate the importance of your P&Ls, you have to know how they impact your business. Sure, you know profit is good and loss is bad. However, the implications of your P&Ls are a bit more complex.
What factors impact your P&Ls?
- Efficiency. Are you operations working at maximum efficiency?
- Sales. Are your sales volumes high enough to offset your costs?
- Waste. Are you utilizing your resources or generating waste?
- Cash Flow. Are you generating enough cash flow to support you spending patterns and ability to meet demand and grow your business?
Common Terms: How to Figure Out Profit and Loss
Terms like “gross profit,” “COS” and “interest expense” are usually the reason you put your statement down in the first place, right?
Before we get into a few equations that are important to your P&L statement, let’s clarify some common terms that you often see.
- Sales – You may see this as “revenue” or “income.” All terms have the same meaning.
- Cost – You may see this as “expenses.”
- Profit – You may see this as “net income.”
- COS (Cost of Services) – This is the amount of money involved with delivering a service. If you owned a barbershop, for example, your COS would include money spent on your products and tools, your employees’ salaries, etc. This is a type or category of cost.
- COGS (Cost of Goods Sold) – Your COGS are your expenses directly related to the cost of production or services provided. Let’s say you owned a company that provides IT services. Your COGS would include your support ticket system and/or software, the phone and web services your technicians rely on, the computers and servers you use, and the salaries of your technicians and professional team. This is a type or category of cost.
- Sales and Marketing (Customer Acquisition Costs) - These are the costs related to your cost of acquiring a customer. Consider the money spent on sales and marketing to prospects versus the money gained from each prospect that becomes a customer.
- G&A (General and Administrative Costs) – These are all of your other costs, unrelated to actual service or manufacturing, but still essential to your business. This includes your administrative staff, your accounting department, your office supplies, or anything else that’s not directly related to your goods or services. This is a type or category of cost.
- Operating Income – This is your profit, after operating expenses, excluding taxes and interest expense.
- Interest Expense – These expenses are your costs incurred for borrowed funds. This is a type or category of cost.
- Pretax Income – Your pretax income is the difference between operating revenue and direct expenses (excluding taxes).
Basic Formula for Profit and Loss
Don’t let the large quantity of terms overwhelm you. Deciphering your P&L statement is a lot easier than you think. Start by evaluating your P&Ls from the most basic perspective. The equation for determining your gross profit is simple:
Sales – COS or COGS = Gross Profit
Your revenue minus your costs for goods or services is your gross profit. It follows a basic Sales – Cost = Profit equation. You’re just subtracting a different category of cost. When you have your gross profit figure, use that number to determine your total profit.
Sales – Cost = Profit
Or more specifically:
Gross Profit – (R&D,+ S&M,+G&A) =Operating Profit
From here, you can determine your operating income as:
Gross Profit – Operating Expenses = Operating Income
This is all useful information, but its value lies in its application to your business strategy. Think of your P&L numbers as your monthly scorecard, highlighting what went well and what areas need improvement. When you understand all of the costs your business is incurring, you’re able to make informed, smart decisions about cutting these costs and boosting your profits.
That’s where a financial partner comes in. While you may know the basics about your profits and losses, an experienced financial partner understands the application. Work with them to understand the numbers behind your business, and you’ll start to see an overall increase in your profitability.
Need to find the right financial partner for your business needs? Talk to a G-Squared advisor for more information.