If you’re a business owner, you can’t be expected to know everything about your company’s finances, especially if you’re not financially trained. But there are some aspects of your accounts that you need to understand – including your profit and loss (P&L) report.
What is a P&L report?
A P&L report (or statement) provides a snapshot of your business’s financial performance over a specific period, typically a month, quarter, or year. It outlines your revenues, costs, and expenses, and ultimately, as its name suggests, lets you know whether your company is running at a net profit or a loss.
Why is it important?
Without an accurate profit and loss report, you and your team will struggle to make informed decisions, drive future growth, and make sure your operations remain sustainable. It doesn’t just provide an indication of your profitability – it guides your business strategy.
What are the key components of a profit and loss report?
A standard P&L report is typically divided into several sections:
Revenue (sales)
This is the total income generated from your business operations. It includes all the sales of products or services before any expenses are deducted. For service-based businesses, this might be fee income, while for product-based businesses, it would be product sales.
Gross revenue: This is your total sales before any deductions are made, like returns or allowances.
Net revenue: This is your total sales after adjustments for returns, discounts, and allowances.
Cost of goods sold (COGS)
COGS represents the direct costs associated with producing the goods or delivering the services sold by your business. For a product-based business, COGS might include raw materials and manufacturing costs, while for a service business, it could be the labour costs that are directly tied to service delivery.
Gross profit
COGS is subtracted from revenue to calculate the gross profit. It reflects the profitability of your core operations before considering other operating expenses.
The gross margin – which is your gross profit as a percentage of your sales – is a good metric for indicating how efficiently you are producing or delivering your product or service.
Operating expenses
These are the costs necessary to run your business that aren’t directly tied to producing goods or services. Operating expenses could include advertising and marketing campaigns, sales commissions, office supplies, utility bills, rent, some salaries, and depreciation of any assets you have purchased previously.
Your operating expenses are deducted from your gross profit to determine your operating income (or operating profit).
Operating income
Non-operating items
Non-operating items include any revenue or expenses that don’t come about as a result of your core business activities, such as interest earned, one-time gains or losses, or investments.
Net profit (or net income)
Found on the bottom line of your P&L statement, your net profit (or net income) reflects the overall profitability of your business after all expenses, including taxes and interest, have been deducted from total revenue. A positive net profit means your business is profitable, while a negative net profit indicates otherwise.
5 clever ways to use your profit and loss report to better understand your business
Here’s what you need to focus on when analysing the data that’s found in your P&L statement:
1. Identify revenue trends
Look at your sales over time to identify trends. Are your revenues increasing, decreasing, or stagnating? Understanding revenue patterns is critical for forecasting your future performance and identifying whether your marketing and sales efforts are working. You can also break down revenue by product lines, services, or customer segments, so you can see which areas of your business are thriving and which may need attention.
2. Assess gross profits (and their margins)
A healthy gross margin varies by industry, but generally, higher gross margins mean you are retaining more of every pound as profit. If your gross margin is shrinking, you may need to reassess your pricing strategy, reduce production costs, or eliminate unprofitable products or services.
A declining gross profit compared to previous periods could mean that your production processes aren’t very efficient, or rising costs aren’t being passed on to customers.
3. Keep an eye on operating expenses
Are they increasing faster than revenue? Compare them to previous data to ensure they’re not eating into your profitability.
While some expenses like rent or utilities may be fixed, others, like marketing and administrative costs, can be managed. If operating expenses are rising, work out which ones can be reduced or at least streamlined without harming your business activities. You should also review specific categories of expenses to pinpoint areas of waste or overspending.
4. Understand your break-even point
Your P&L report can help you calculate your break-even point, i.e. the level of sales at which your revenue exactly covers your expenses. Knowing this figure allows you to set realistic sales targets and understand how much revenue you need to generate to start making a profit, if you’re not already.
5. Combine your P&L data with your cash flow forecast
While a P&L report shows profitability, it doesn’t reveal the full picture of cash flow. Your business can be profitable but still face cash flow issues due to delayed payments or high receivables. It’s important to review your cash flow statement in conjunction with the P&L report to get a complete financial picture.
As you can see, your profit and loss report can give you valuable insights into the financial health of your business and highlight its strengths and weaknesses from a fiscal perspective.
If interpreting your P&L is way out of your comfort zone, or you simply want a fresh pair of eyes on your figures to give you extra reassurance that all is well, it could be time to hire a bookkeeper.
