How To Read & Understand Your P&L
Posted on 3rd February 2021 at 10:00
The P&L is something that, while bigger businesses take it for granted, can be somewhat scary to smaller businesses.
If you’re not used to managing finances or dealing with statements like this, a P&L can seem like a daunting pile of numbers that don’t really mean anything – and so a lot of business owners just avoid doing it.
And while you do not have to generate or submit one for things like annual accounts, it’s always a good idea to take a look once in a while. If nothing else, it can give you a startling insight into what is really going on in your business. But if you have never seen one before (or have and did not understand it), how does a P&L work?
What is a Profit & Loss?
The first step to understanding your P&L is to know what it actually is and what its job is. In simple terms, a P&L (Profit and Loss) statement is a financial statement that summarizes the revenues, costs and expenses incurred during a specific period.
These are usually best done once a quarter and can be used to give you an idea of the company’s ability (or inability) to generate profit by increasing revenue, reducing costs, or both. Sometimes a third party might ask to see a P&L as a way of evaluating your business profitability, particularly if you are doing things like applying for finance. As a business owner, your P&L can give you some great insights into how profitable your business really is, and what changes you could make to be more efficient. But, first you need to know how it works.
So how Do I read a Profit & Loss?
There are 3 main sections to a P&L statement: revenue, expenditures, and the bottom line. Essentially any line item listed on a P&L will fall into one of the first two umbrella categories, and the bottom line brings it all together. Under those three umbrellas are a few basic categories:
Revenue is made up of:
All the sales you make
Other payments made into your business. For example, any money made from selling old machinery, property, or a tax-refund. These tend to be one-time revenue generation events rather than regular income.
Expenditure comes in a few forms, including:
Cost of Goods Sold: How much it costs you to create the product you sell. For example, if you sell a shirt for £25, you put £40 in the sales column above, but you do not actually ‘make’ £40. If that shirt cost you £10 to purchase at wholesale, then you made £30 profit, and the cost of goods sold is £10. If you are dealing in physical products this is simpler to do, whereas if you are working with services you would calculate the time hours devoted to a particular project.
OPEX: OPEX is short for “Operational Expenditures” and simply takes into account “what it takes to run your business in addition to the cost of goods sold (COGS).” OPEX includes things like employee salaries; meals and entertainment; travel and training; office space rental and utilities costs; computer hardware and software; maintenance expenses; marketing communication and advertising expenses; telephone and internet services; insurance costs; external consultant fees… the list, depending on your type of business, can go on and on.
Depreciation: The cost of the physical items in your business, like computers, phones, vehicles or machinery, will be generally allocated over the length of time that you own the asset. That does not mean you never pay up-front for it, but it does mean that it loses value each year and can be counted as a loss to your business come tax time. Which can be pretty helpful!
Profit is where it all comes together. This is the final line on the P&L, which is where it earned its name ‘the bottom line’. It works out what your business profit is by doing a slightly more complicated version of the sum revenue – expenses = profit. This is what you really make in terms of money, and for a lot of businesses this is enough information to go on with. There are some slightly more advanced elements you could go into, but that pretty much covers the basics.
At DeerBridge we are here to help. As your businesses financial support, we can help you generate, read and understand your P&L, and support you in making business decisions based on the information it reveals. We work closely with business owners and executives to really help you get a handle on your business profitability and use that information to kick-start your next stage of growth. If you would like to find out more about financial control, just get in touch with us today.
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