Starting a small business is an exciting time as you work to bring your dream to life. Of course, while you want to take advantage of every opportunity, the truth is that your business might not be in the financial position to take advantage of them. But how can you determine whether your business is in a solid financial position? It starts with understanding your financial statements and what information they are providing, as well as how to analyze that information. With that in mind, let’s dive into one of the primary aspects of your financial statements, the profit and loss statement (P&L).
What Is a Profit and Loss Statement?
A Profit and Loss Statement refers to the financial statement that summarizes the revenue, costs, and expenses your small business has incurred during a specific period, such as the fiscal year or a quarter. Your P&L provides essential information that demonstrates your company’s ability or inability to generate profit, either through increasing revenue, reducing costs, or a combination of both. They are often presented on a cash or accrual basis. Clearly, the information found here can let investors and financial institutions know how financially healthy your small business is.
What Is Included In a P&L Statement?
When you look at your P&L statement, you have a snapshot showing what your company owes and owns at a specific moment in time. By comparing P&L statements, you can begin to see trends in revenue and expenses that explain why your company is profitable or where you need to focus your attention to improve profitability.
There are five categories included in the P&L:
- Revenue or gross income from all sources, either by generating income from sales or income from interest and subscriptions.
- Direct costs (COGS) are directly associated with revenue generation, such as inventory or manufacturing.
- Gross profit, which is revenue minus direct costs.
- Expenses, which include operating and non-operating.
- Operating profit, which is the cash left over after paying all the expenses. If your costs exceed your revenue, then you could be generating a net loss.
By comparing income statements (P&L) from several accounting periods, you can begin to identify trends in spending and sales. For instance, you might see your sales trending upwards, which is a good sign of the financial health of your business. But then, you notice that your expenses have tripled in the same amount of time, wiping out any profits from the increased sales. That analysis gives you the data necessary to start analyzing your costs, looking at efficiency and cost-saving measures.
When used together, the P&L statement, balance sheet, and cash flow statement provide an in-depth look at a company’s overall financial performance.
Why Is the Profit and Loss Statement Important?
A P&L statement provides investors and analysts the information they need to assess your profitability, combining this data with insights from your balance sheet and cash flow statement. For instance, your return on equity (ROE) can be compared to your net income on the P&L to the level of equity as found on the balance sheet.
However, the benefits of being able to analyze your P&L statements are limited if they are inaccurate or full of transactional errors. With that in mind, how often should you review your P&L?
How Often Should I Look at my P&L?
Most business owners look at their P&L statements either monthly or every quarter. While you might opt to look at them less frequently, it is essential that you have a regular routine of reviewing them. Doing so can assist you in identifying areas where attention might needed, such as with rising expenses or slowing revenue streams. Once you identify a cost that needs to be cut, you can negotiate with your vendor or find an alternative supplier. It can also draw your attention to the need to increase efficiencies in your production, shipping, or administrative operations.
Small business owners can also benefit by comparing their P&L statements with other companies in the same industry and similar in size to evaluate their financial well-being. Are your expenses in line with industry standards? Doing these comparisons can assist in revealing whether your business is efficiently managing expenses and whether it has solid growth potential.
Can I Hire Someone to Create My Profit and Loss Statement Each Month?
Like the rest of your financial statements, your bookkeeper can compile these reports on a monthly basis after reconciling your accounts. After they have been created, it is key that you review them. Doing so will help you spot any potential errors right away instead of waiting until the quarter to address them. Plus, your bookkeeper or bookkeeping service can also work with you to keep the data that feeds your financial statements current and accurate, so your analysis of the financial information will not be made with faulty data.
Another benefit to a monthly P&L is that you have the ability to change trajectory right away or identify areas where cuts can be made to get your business back on track. This type of information is also essential to managing your cash flow effectively from month to month.
Frequently Asked Questions
Can a profit and loss statement help with budgeting?
Yes, because you can see what categories are the largest in your expenses and work to bring those expenses down. You can also create your budget to accurately reflect your spending based upon your P&L if it is not out of line with the industry standard.
How can a profit and loss statement be used for decision-making?
As a business owner, your P&L breaks down your company’s costs and gains, thus offering key insights into growing your revenue and upping your chances of success. Use it to identify trends and drastic changes, as well as to identify areas of improvement. Continue keeping detailed records so your P&L statement is as accurate as possible for analysis.
What is the difference between gross profit and net profit?
Gross profit represents the income or profit remaining after production costs are subtracted from your revenue. It helps you to determine how much profit you are making from producing and selling your goods and services. Net profit is what remains after all the expenses and costs have been subtracted from the revenue, reflecting how effectively the company is being managed. It also helps you to determine whether you are earning a profit and, if not, where your business could be losing cash.
How can small business owners analyze their profit and loss statements?
Compare statements from different time periods to understand sales trends, analyze costs, and determine where you need to cut expenses while increasing revenue sources. Always meet with a CPA to discuss structural changes that could positively impact your profitability.
What Is AccountsBalance?
AccountsBalance is a monthly bookkeeping service specialized for agencies & SAAS companies.
We take monthly bookkeeping off your plate and deliver you your financial statements by the 15th or 20th of each month.
You’ll have your Profit and Loss Statement, Balance Sheet, and Cash Flow Statement ready for analysis each month so you and your business partners can make better business decisions.
Interested in learning more? Schedule a call with our CEO, Nathan Hirsch.
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A P&L statement is an overview of your business and its performance by showing revenue, direct costs, and business expenses. However, it is just one part of your financial statements. Taken together, your P&L statement, balance sheets, and cash flow statements provide a detailed snapshot of your company’s financial health. While you can analyze your P&L statement, there is much information to be gleaned from the combination of all three aspects of your financial statements.
To be sure they are accurate, it is important that you focus on accurate bookkeeping since your financials are only as accurate as the data being put in from your accounting software. If you are ready for assistance with your bookkeeping, consider the benefits of working with a top-notch bookkeeping service today.