Profit and loss statements (also referred to as income or earnings statements) are among the most essential reports a business produces, as they highlight all revenues, costs and expenses over an agreed-upon timeframe.
Sales typically appear at the top of a P&L statement, followed by Cost of Sales (or Cost of Goods Sold, COGS) and operating expenses as well as non-operating expenses that subtract from gross profit to yield net profit which is then displayed at the bottom.
Understanding your Profit and Loss (P&L) statement is critical to sustainably expanding your business, so this guide is here to assist in understanding this essential document and what its contents reveal about your business.
Income
On the top of your P&L is total revenue, including any income generated through sales, investments, interest or any other means. On the bottom is net profit - that amount left after subtracting all business expenses from total revenue.
As part of your P&L statement analysis, it's essential that you monitor the revenue performance and expenses during each period. Comparing results against earlier ones allows you to identify any trends or red flags that may exist and should prompt further examination.
Cost of Sales
The cost of sales (also referred to as cost of goods sold or COGS) is an expense item on your profit and loss statement that shows all direct costs involved in creating products or services you sell, such as raw materials and direct labour costs. It does not include indirect expenses like depreciation of machines, warehouse utilities fees, stock-based compensation packages and amortisation of intellectual property intangible assets; making this category somewhat subjective when choosing which expenses belong here over others.
Subtracting total revenue from total cost of sales provides an indication of how much profit was realised from your sales efforts. This calculation serves as a key part of evaluating your business's financial health, helping you make decisions regarding its future and make strategic plans accordingly. If it appears that you're losing money due to poor management decisions or high costs, this could be an early warning signal that needs addressing immediately - for instance if your profit and loss statement indicates you're losing money, which might indicate it might be time for changes such as changing business model or finding ways of cutting costs.
Operating Expenses
Operating expenses comprise the next section in a P&L statement and include any costs that do not form part of the cost of goods sold. Expenses that are included in operating expenses include: employee salaries, supplies, office equipment and facilities, inventory and advertising. Unlike capital expenditures and COGS, these costs do not directly relate to the production of a business’s products or services.
P&L statements contain an "Expenses" line, which details all costs that were incurred by a business during a given period. To spot trends over time and stay competitive, it is vital to evaluate this cost line closely.
If your operating expenses are increasing more rapidly than your revenue, this could be an indicator that you are spending too much money on overhead. Conversely, it could provide opportunities to find ways of cutting costs without negatively affecting quality or customer experience - this is why analysing your profit and loss statement is so essential.
What can I use this information for?
Your business's "net profit" - which measures whether or not earnings outstrip expenses - should serve as the ultimate measure of its success or failure. If your net profit is less than your operating expenses, you may be losing money. However, you can also see how much your expenses are higher than your sales, which reveals the amount of revenue that is going into a business's operations and not out of it.
In addition, it allows you to review your operational costs and assess the efficiency of your operations. For example, if your overhead is high, consider reducing some of these costs.
Similarly, you can check the profitability of new offerings by reviewing your P&L statement. You can also use this information to analyse seasonality and evaluate income sources.
You can use your P&L statement to understand the impact of holidays on your COGS, sales, and profits. This can help you to identify opportunities for new products that will drive more sales during off-peak times. It also helps you understand what you can do to increase revenue to boost your bottom line.
The profit and loss statement for your business is one of the most important financial statements you can prepare. It can be useful for small businesses and incorporated companies to improve transparency about their finances.
It can also be used to show investors and lenders your company’s financial health. Financers use this information when they decide whether to invest or lend money, while internal users like the management team use it to analyse how the business is running and make decisions that help turn a profit.
A profit and loss statement are a document that summarises a business’s revenue, expenses and income over a certain period of time. It helps you understand the performance of your business at specific periods and compare it with other reports.
Here at Allomes Accounting and Auditing we will help you understand your financial statements and equip you with the knowledge so that you can make better business decisions for your business based on your business records. Contact our office today to set up an appointment with our accountants.