Unless you’re a seasoned financial professional, reading a profit and loss statement can be a headache-inducing task. Steven L. Wilson, founder of Steven L. Wilson and Associates, tells U.S. News and World Report that they are even among the hardest documents for accountants to have to interpret.
Because there is such a level of information to process, it’s widely recommended that you seek the help of someone who has experience with P&L statements to ensure that you are on the right track. Still, there is information that you should know to improve your understanding of what and how these useful reports work.
What is a profit and loss statement?
Per Investopedia, a P&L statement — also known as an income statement — summarizes a businesses’ costs, expenses and revenues over a certain period of time. It’s common for P&L statements to be issued for a calendar year or fiscal year, quarter, month or even on a weekly basis. It should not be confused with your balance sheet or cash flow statement, but all three statements should be looked over in conjunction to get the fullest picture of how your business is doing.
Doug and Polly White, co-authors of “Let Go to Grow: Why Some Businesses Thrive and Others Fail to Reach Their Potential,” tell Entrepreneur that a profit and loss statement is based on the simple equation of sales minus costs equals profit. Sales and costs are typically broken down into different subcategories to provide a clearer picture of every working component of a business, which is beneficial both for your understanding of your business and for the understanding of any investors of financial institutions you might turn to for support.
What do you need to know?
Ultimately, the most important part of a P&L statement is your bottom line, which tell you whether or not your business is turning a profit. If you are preparing a P&L for investors or financiers, profit will be heavily considered, but they will certainly do their diligence to ensure that all of your other numbers appear sound.
Marco Carbajo, writing for the U.S. Small Business Administration, counts pricing and gross margin as two of the key areas to track on your P&L statements. Pricing has a significant impact on your ability to make profit, and Carbajo recommends ensuring that your business is selling its product for the unit cost — the labor and materials used in production — plus 45 percent at minimum. If you not pulling in 45 percent on top of unit cost for your products are services, it will become necessary to consider the options of raising your prices or lowering unit cost to cover the difference.
Gross margin is the net revenue less the cost of goods sold, and it is the lifeblood upon which your business depends. As Carbajo notes, this is the money you use to pay operating and variable expenses, meaning you’ll struggle to keep the lights on if your gross margin is too low. To ensure that your business can sustain itself on your gross margin, you will want to make sure that you are hitting that same unit cost plus 45 percent price point and minimizing expenses as much as possible.
A profit and loss statement is essential for measuring the pulse of your business, and it can mean the difference between getting the backing of investors or being left to fend for yourself. Because it is so important, you’ll want to consider seeking the services of a financial expert for the preparation and interpretation of your business’s P&L statement. Sit down with your accountant and go over these reports so that you will have a full idea of how the business is doing and where it has the potential to go.