28 Aug Understanding Your Profit and Loss Statement
Let’s face it, when you started a business, it probably wasn’t because you were excited about doing your own bookkeeping. Things like your profit and loss statement, accounts payable, and cost of goods sold likely don’t get your blood pumping.
Unless, of course, you’re part of the team at Two Roads!
Today, we’re going to discuss your profit and loss statement and share some useful tips for understanding exactly what it’s telling you and how to use it.
Let’s get started with the basics.
What is a profit and loss statement?
A profit and loss statement, also known as a P&L, is synonymous with an income statement. It includes the revenues, costs, and expenses incurred during a fiscal quarter or year or another specified period of the year.
Along with the balance sheet and the cash flow statement, a P&L is one of three financial statements a public company issues both quarterly and annually.
Whether you create your P&L on your own or someone does it for you, you might never bother using the information on it simply because you don’t understand what it’s telling you.
So now, let’s break down the information on a profit and loss statement to clear up any confusion!
Understanding your profit and loss statement
First, you should know ALL P&Ls are based on a simple formula: sales – costs = profit.
That means there are three primary components of a P&L: sales, costs, and profits.
Where this can get confusing is there are often different terms used for each of these.
Instead of sales, it might say revenue or income. And rather than costs, it may list expenses. Finally, instead of profits, it could use the term net income. But once you’re clear on the language in your P&L, it gets much easier to understand.
While you’re here, you’ll also want to check out this post on cash versus accrual accounting for your small business.
Whether your profit and loss statement uses sales, revenue, or income, here’s what you should know about this component.
Depending on the structure of your business, your sales are often broken down into further categories. For example, a restaurant might have a sales column for dine-in, another for take-out, and a third from catering. Then, in the total sales column, these three are combined. Or, if you’re a non-profit, your sales/revenue might come from fundraising.
Speaking of accounting for specific industries, check out this post on bookkeeping for marketing agencies.
In most cases, your costs are broken into different categories too.
Let’s say you’re a kitchen contractor. Your costs/expenses might be divided into material costs, labor, and overhead. Similarly, costs are usually broken into various components. For example, you may see material costs, labor costs, and overhead broken out separately.
There are all kinds of ways to divide your costs depending on your business, but the total costs column is the one you’ll focus on most.
Finally, we get to the profits or net income column. The bottom line.
This column usually isn’t divied up any further, as it represents your total sales minus your total costs. If this number is positive, it represents a profit. If it’s below zero, it’s indicative of a loss. Hence the name “profit and loss statement.”
What else to look for in your profit and loss statement
We’ve covered your P&L statement in the broadest terms today. But depending on the specific business you run, it could include a variety of other terms. Here are a few of them:
Direct costs: This is also referred to as the cost of goods sold (COGS). These are costs you incur when you make your products or deliver your services.
Gross margin: Your gross margin represents how much money you have left to cover expenses once you’ve covered the cost of the product or service you are selling.
Operating expenses: This includes the expenses you incur to keep your business running, not including COGs. It can include rent, salaries, and benefits, research and development, utilities, etc. Just remember, it doesn’t include the interest you pay on loans or taxes.
Operating income: This is also called EBITDA (earnings before interest, taxes, depreciation, and amortization). Your operating income is calculated by subtracting total operating expenses from your gross margin.
Get help with your bookkeeping from Two Roads
We’ve covered the basics of understanding your profit and loss statement here today. But it’s just a fraction of the critical bookkeeping tasks your business needs for success! If you’re feeling overwhelmed with keeping up with your books, we can help.
Two Roads is a bookkeeping company that understands small business. Our passion is to give business owners like you the freedom to grow and manage your business while we take care of the paperwork.
Simply put, we free you up to do what you do best.
Does that sound like exactly what you’ve been waiting for? Call us today!
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