How to Manage Your Business’s Profit and Loss
A profit and loss statement provides information about an entity’s financial performance over a given period of time. Having the ability to read and understand financials (including the Profit and Loss statement) helps in reducing unnecessary expenses and increasing profitability.
Profit and loss management is the process of finding ways and methods to increase revenue and reduce costs. You can initiate this process by analyzing your entity’s P&L statement (also known as income statement). Since, the Profit and Loss statement breaks down an entity’s income and costs, it provides important information about an entity’s revenue and costs which if used wisely could help the business in achieving growth and success in the future.
In this session, we will learn about the following:
- What is Profit & Loss Statement?
- What is Profit & Loss Management?
- What information is mentioned on a Profit & Loss Statement
- How should you use your Profit & Loss statement to manage your profit and loss?
- The best financial tools for preparing a Profit & Loss statement
What is a Profit & Loss Statement?
A P&L statement can be described as a sheet which breaks down an entity’s revenue and costs by categories to show its net profit or loss. Generating a Profit and Loss statement is the first important step of managing income and expenses. It presents your income and expenses clearly and gives you the starting point to find ways of reducing costs and increasing revenue to ultimately increase the profitability.
The statement of financial position (also known as balance sheet), the income statement and the statement of cash flows are considered as three of the most integral financial reports for analyzing an entity’s financial performance and position. Analysis of these statements allow you to see how well your business is performing at any given time.
If you’re thinking or planning on taking a small loan for your business then in most cases the lender would require you to submit audited financial statements audited by a reputed audit firm in Singapore and a business plan that should include a P&L statement too. From the initiation of your business, you would be required to prepare a P&L statement on a frequent basis.
A well established business should ideally prepare a P&L statement on an annual basis. This helps in mapping your income and expenses over a 12 month period. However, generating monthly profit and loss statements provides better insights into how a business is performing on a monthly basis. Monthly analysis allows you to timely proactive decisions to ensure your year end targets are met without a surprise.
What is Profit & Loss Management?
Profit and Loss management means using your P&L statement to make better informed business decisions regarding your business. Most importantly, P&L management doesn’t necessarily mean to determine how much you earn—it also means how much money you’re losing out on expenses.
When you map your income and expenses, you can identify loopholes and gaps in your expenses and defuse financial problems/ issues before they become major losses.Bottom of Form
What information is Mentioned on a Profit & Loss Statement?
A P&L statement is typically classified into two categories: one is the revenue category and the other is the expense category. When preparing an income statement, all the expenses are subtracted from income to calculate the entity’s net profit. Typically, your income statement shows the profits or losses you have made over a given time period.
Revenue: Revenue also known as gross income represents the amount which an entity earns by selling goods or services. When you calculate revenue, ensure that you consider all the income sources. This could also include interest earned on investments.
Direct Costs: Direct costs are expenses that are directly related to delivery of a service or manufacturing of a product. In other words, any expense that is directly related to an entity’s services or products is a direct cost. If your business sells a product instead of a service then your direct costs can also be referred to as the cost of goods sold (COGS). The formula for calculating cost of goods sold is as follows:
Cost of Goods Sold (COGS) = Opening inventory + Purchases – Closing inventory
Gross Profit: Your gross profit represents the amount earned by the business during a specific time period. A gross profit of a business is calculated by deducting direct costs of a business from its revenue.
If your direct costs exceeds your revenue then it means you have a gross loss. When that happens, you can use your financial statements including the profit and loss statement to obtain information that will help you in turning that gross loss into a gross profit. For example, you may discover that you are not charging your customers enough per unit of a product to cover your COGS, and increasing your prices a little bit could help you in turning your loss around. The formula for calculating gross profit is as follows:
Gross profit = Revenue – Cost of Goods Sold
Operating Expenses: These are all those expenses which a business incurs to meet its operational needs on a daily basis. Utilities, Rent, advertising expenses and equipment maintenance are some of the examples of operating expenses.
Non-operating Expenses: These are costs that are incurred less frequently when compared with operating expenses. These aren’t essential towards running an entity’s operations on a daily basis. Hiring a lawyer and paying interest on a loan would be considered as examples of non-operating expenses.
Depending on the nature and structure of your business and the accounting and bookkeeping solution you use to manage your books, you may list all of your expenses instead of differentiating between operating and non-operating expenses.
Net Profit: Net profit represents the amount of money a business earns after deducting all its operating and non-operating expenses from its gross profit. If the total of operating and non-operating expenses exceeds the entity’s gross profit then it means that the entity has incurred a net loss.
Net profit is an important parameter that helps businesses in determining their financial health. It helps a business in finding out whether it can earn more than it spends. A business can use its net profit as a base for making decisions relating to business expansion.
For a business owner, it is important to know the difference between profit and profitability. Profit is an absolute number which is equal to revenue minus expenses. Profitability, on the other hand, is a relative number (a percentage) which is equal to the ratio between profit and revenue. Profitability is a measure of efficiency and it is useful in determining the success or failure of a business.
The formula for calculating net profit is as follows:
Net Profit = Gross profit – Total of operating and non-operating expenses
How should you use your Profit and Loss Statement to Manage your Profit and Loss?
Preparing a P&L statement is just a part of managing your business’s statement of profit and loss. Once you’ve prepared the profit and loss statement then perform the steps mentioned below to find out how profitable your entity actually is against how profitable it can be:
- Compare your profit and loss statement for the current period with previous years’ statements. If any drastic change has happened then identify how and/or why that change occurred.
- Meet with financial analysts or accounting firms to get help in identifying areas that need to be strengthened going forward.
- Continue keeping and maintaining records of your entity’s profits and losses so you that those records could assist you in preparing P&L statements of future periods.
The Best Financial Tools for Preparing a Profit & Loss Statement
Any cloud-based financial recording and management solution should have a Profit and Loss statement. Accounting solutions such as Odoo, XERO, and QuickBooks Online are our top picks when it comes to software with excellent financial reporting. These software solutions are known for providing profit and loss statements, quarterly and monthly summaries, and customer-wise profit and loss statements and a lot more. You can also download a template of the Profit and Loss statement and that too free of cost to use with your favorite word processing or spreadsheet software such as Google sheets and MS Excel.
Strategic P&L management guided by a thorough and detailed P&L statement will help you in keeping your earnings positive and minimizing your expenses. Generating P&L statements on a frequent basis, meeting with accounting experts to review findings, and implementing changes as needed are the main steps to improve your business performance.