The difference between running a business and having a very expensive hobby can sometimes lie in the profit your business actually makes. One sure way to tell which you have is through a profit and loss statement. This is an essential document even the smallest business owners can use.
Although being able to boast of high turnover and sales figure is nice, your P&L statement shows an accurate picture of just how much it costs your business to make those sales and keep running.
Having a clear understanding of your profit and loss is essential for:
- Planning how much you will spend on your business
- Your ability to repay debts and service loans
- Being able to pay yourself
Knowledge is power — let’s explore how you can seize yours.
The P&L statement: your new secret weapon
So many small business owners fly blind, making decisions about when to purchase equipment or hire staff on their gut feelings. There is a better way — consult the P&L.
- Tally your income.
- Add up your expenses.
- Subtract your expenses from total income.
- Pay the tax man.
Before we walk you through creating your first profit and loss statement, let’s explain simply what this basic business report is.
What is a profit and loss statement?
Profit and loss statements can be a source of confusion for many new business owners. Usually they’re pushed aside by more pressing matters … until you go to apply for a loan or it’s tax time.
But far from being a once-a-year exercise, your profit and loss statement can be the tool that allows your business to thrive and grow sustainably.
Profit is often confused with income, which is how much money your business makes from selling goods and services.
Profit is actually what’s left over from your income — once you take out expenses like the cost of the product or service and the costs of running your business.
A P&L statement is a vital document, because it can give a clear picture of the financial health of your venture. As such it can provide early insight into any areas of concern, while there’s still time to remedy them.
How do I prepare a P&L statement?
Generating a profit and loss statement is simple if you use online accounting systems such as Xero, QuickBooks or MYOB.
Depending on your business model, the number of transactions going in and out each week and how tight your cash flow is, it’s a good idea to update your P&L statement once every three months (quarterly) at a minimum. Monthly or even weekly profit and loss statements will give you tighter control and help you quickly plug any holes that are draining your profits.
Gathering the numbers
Before you can prepare your profit and loss statement, you need to have your financial figures ready for the period you wish to calculate.
For product-based businesses, you would need to have the costs of the goods themselves, including raw materials if you make them yourself. You would also need all of your expenses related to selling the goods or services, which might include:
- Marketing and advertising
- Website costs
- Staff or outsourcing
- Rent and insurance
If you have a bookkeeper, you can ask him or her to provide totals once every three months.
How to create your statement by hand
If you don’t use accounting software, there are plenty of online templates available. Pick one and then just enter your expenses and income to calculate your profit and loss.
Look for templates in formats you use already, such as Excel, that are prefilled with formulas.
Step 1. Tally your income
Add up all of your income from every source for the period you are calculating. Doing this at least quarterly will give you the ability to see seasonal trends.
If you have different income streams, it may be helpful to break down your profit and loss by each stream to see where expenses might be higher than usual, or if an item is actually costing more than it makes in income.
Jimmy’s Lawn Mowing Service has 60 regular clients who pay $100 a month. To calculate P&L for one year:
$100 x 60 x12 = $72,000
Step 2. Add up your expenses
List all the expenses for the period — the cost of goods sold and operating expenses — and then add these together.
Jimmy’s Lawn Mowing spends $20 per client per month in fuel and products (cost of service). Over the year, his business expenses for marketing, a website, equipment and maintenance amount to $15,000.
Add up 20 x 60 x 12 = $14,400 + $15,000 = $29,400
Step 3. Subtract your expenses from total income
Subtract the total expenses from your income to get your operating profit (your income after expenses are subtracted).
$72,000 – $29,400 = $42,600
Step 4. Pay the tax man
Subtract any taxes due from the operating profit.
The amount of tax you need to pay will vary depending on your business structure and other income. You can find a tax calculator here.
Let’s say Jimmy had to pay $10,000 in tax:
$42,600 – $10,000 = $32,600
How can I use this statement to improve my business?
Creating a profit and loss statement gives you a very clear picture of how your business is doing. Now that you have it, you can:
- Calculate your gross profit margin — in other words, the percentage of your total revenue that becomes profit. The higher the percentage, the better your business is performing.
- Compare financial periods to identify seasonal trends or problems
- Find areas where costs can be cut
- Look at ways you can invest the profits back into the business, perhaps hiring staff or buying equipment
- Use the information to plan cash flow and predict profit for next year
- Determine exactly how much profit you’re making on each sale
This will also reveal your ‘break-even’ point in the year, when your expenses for the entire year will be paid and the rest of the income for the year is profit. This can then be used to set a challenge to reach profitability earlier next year.
More than just the bottom line in business
Profit and loss statements do more than just provide a ‘bottom line’ view of the financial health of your business. They give you the power to make smart decisions.
To create a P&L statement, you need to deduct all of the expenses relating to running the business from the income that you make. This then gives the amount of profit that will be subject to tax. Everything left over is considered your profit.
As a business, this final figure (gross profit) can be used to provide a percentage figure to see how much of your income is kept as profit after expenses. Keeping track of the gross profit margin as a percentage of income on a quarterly basis makes it easy to see if expenses and income are going up or down and take quick action to stay on track.