Understanding A Profit And Loss Statement
If you haven't taken the time to wrap your head around your company's profit and loss statement - how can you expect to truly know how much you're making?
According to the Australia Bureau of Statistics, more than 60% of small businesses cease operations entirely within their first three years of trading. One of the most common reasons that they fail is due to a lack of cash available to meet their expenses, particularly within the first six to twelve months - and these figures were issued before the arrival of Covid-19.
In order to build a healthy and consistent cash flow stream, you’ll first need to know exactly what’s coming in - and what’s going out - of your business, and the data can all be found in your profit and loss statement. So where do you start?
What Is A Profit And Loss Statement?
A profit and loss statement, also known as an income statement or report, is designed to show the profitability of your business over a specific period (or lack thereof). It can cover any period of time, but is most commonly produced monthly, quarterly or annually. Although generally produced together, a profit and loss statement is not to be confused with a balance sheet or cash flow report.
Although not compulsory for privately listed companies, a profit and loss report is a useful tool for monitoring business activity. For business owners, it highlights where their business is doing well, and can help to identify certain factors as to why a business might be struggling. Investors will use profit and loss reports to gauge the financial health of a potential investment, or to see what kind of return they are getting on an existing investment.
What’s In A Profit And Loss Statement?
Generally speaking, a profit and loss statement consists of two separate sections: revenue or income gained (profit) and expenses incurred by the business (losses).
The revenue section of your report details all of the income collected from your primary business activities, such as sales accumulated from products or services, plus any revenue sourced from secondary activities such as bank interest or asset sales. It’s also important to note how much your revenue has increased or fallen since your previous profit and loss report, and to record sales by individual products or services as this allows you to analyse the statement effectively and to notice “patterns”.
When it comes to your expenses, there should be two clear distinctions - the cost of goods sold (labour, raw materials needed to produce your goods) and general operating expenses (indirect labour costs, or other costs not directly linked to the production of your goods or services). For some brands, reducing expenses may be easier than increasing revenue, so pay attention to where your primary outgoings are along with any increases. Segregation of the two categories can help you to decide if it’s time to source a new supplier if your materials keep going up in price, or if your primary expense is staff wages.
How To Calculate A Profit
The primary function of a profit and loss report is to determine exactly how much money your business is making after the expenses are sorted. To determine the profitability of your business, the below formulas are actually quite simple.
Gross Profit = Revenue - Cost Of Goods Sold - The difference between total sales and the cost of producing the goods or services you sell. An indicator of overall production efficiency and a key figure for setting prices and sales targets.
Gross Profit Margin = (Gross Profit ÷ Revenue) x 100 - Shows what proportion of gross profit you keep from each dollar of revenue generated (e.g. 20% gross profit margin means you keep a gross profit of $0.20 for every $1.00 of revenue generated).
Operating Profit = Gross Profit - Operating Expenses - Profit generated from core operations. It does not include expenses from interest or taxes (often called “earnings before interest and tax” or EBIT).
Net Profit = Operating Profit - (Taxes + Interest) - Also known as the “bottom line”, this is the net profit is the total amount earned (or lost) after paying all expenses.
Sourcing Help With Profit And Loss Statements
At Muro, we are more than just accountants - we offer our clients strategic business advice, and ongoing support to help them reach their business and financial goals. Get in touch with us at Muro today to ensure that you’re on the right path for success.