Many business owners don’t understand their financials because that is not where their interest lies. They are interested in their product or service. However, it is important to understand your P&L. We’re going to give you the rundown on understanding the basics of a P&L. We’ll also explain the role cloud accounting software that can help you easily generate a P & L statement. You will feel more confident in running your business and understanding your financials.
Why do you need to understand your P&L?
A P&L or profit and loss statement is also called an income statement. It shows you exactly that – what your profit is and what losses you have made. Its primary importance is to show you whether your business made a profit for a period. You can compare a current P&L to previous ones to see if your business has been making more or less profit over time. You can also identify peak periods of profitability. You can use this information to identify whether a business expansion, premises renovation or investment is a good idea. You could also use it to identify areas of particularly high costs to see if you need to reduce them.
How to understand your P&L?
Profit is determined by a basic formula:
If your costs to run the business have been less than your sales, you have made a profit. Usually, your P&L will display these in this order:
These may also be referred to using different terminology. Revenue or income means sales. Expenses mean costs. Net income is another way of saying profit. Don’t feel overwhelmed by the different terminology. Refer to this article when reading your P&L so you can interpret the terminology in your report.
There may be subcategories of sales and costs. Generally, if you have several sales sources, these will be detailed in your report. Similarly, costs will include several subcategories. These subcategories could be:
- Costs of materials
- Costs of labor
If you have a service-based business, such as an electrician, your P&L may be broken down into costs directly associated with performing the service, and those which aren’t. For example, costs of service (COS) would include labor, wiring, and fuses. For a goods-based business, all the costs related to the production of the goods are called cost of goods sold (COGS). On your P&L, sales minus COS or COGS equals gross profit. This is the profit you have made before you account for any other costs associated with running the business, such as rent, utilities and accountant fees. These are operating expenses. They are in a category often referred to as selling, general and administrative costs (SG&A). Gross profit minus SG&A equals profit.
How can cloud accounting software help?
P&L’s by accountants and bookkeepers are usually prepared monthly or quarterly. As the business owner, you may want to see your P&L on other occasions. Often, cloud accounting software can keep track of your income and expenditure in a simpler way. They can offer push-button access to financial reports, such as P&Ls. This will include a P&L template, which means the bones of your P&L are already available. The software will do the necessary calculations and populate the template. This can be done anytime, anywhere.
Using cloud accounting software, as well as the information we’ve provided will set you well on your way to understanding your P&L.
photo credit: Dr John2005 Shoreditch Bridge Portraits 265, Shoreditch High Street, London, 26 August 2016 via photopin (license)