Way back when I started my first business, we either hired an accountant, invested in a proprietary accounting system or did the books ourselves. Excel sheets were the default choice for most of us. But the more time we spent on excel sheets the more complicated it got to keep up the books in order. Then came accounting software and bookkeeping got a lot easier. At about that time I started working with UPS franchises. I immediately realized that that accounting software can help me a lot in quickly creating an error-free Profit & Loss (P&L) statement (also called an income statement) and in running my back-office operations more efficiently. In this blog, I’ll guide you on how to read & analyze a P&L statement like a pro.
How to read & analyze a P&L statement like a pro?
As I briefly explained in the previous blog, a P&L statement is a summary of your income and expenses over a period, generally a month. The P&L statement will show if your business made or lost money over that period. There are various components of P&L statements – all explained below. There are other financial statements such as Balance Sheet and Cash Flow statement. They also indicate the overall health of the business but P&L is most important.
- Sales – Cost of Goods = Gross Profit, Gross Profit – (Variable Expenses + Fixed Expenses) = Profit
- Revenue or Top Line or Sales or Turnover: This is the total of direct services and goods a business sold for that period. For a Car dealership, it could be sales of new cars, used cars or car parts and labor charged for repairs. For a UPS Store, it could be shipping, packing, notary, passport photos mailboxes revenue etc. This is an important number but without a complete statement, it has no meaning.
- COGS or Cost of Goods: This is the direct cost associated with those services. For a car dealership, it will be the cost of purchasing the new and used cars and parts from the manufacturer.
- Gross Profit: A higher gross profit most likely results in higher profit. A lower gross profit may result in a lower net profit or put pressure to reduce direct and indirect costs.
- Variable Expenses: These are the expenses which go up when revenue is increasing. It includes salary for salespeople, Royalty fee, insurance and other costs related to salespeople, some of the office expenses, Credit Card fees etc. This is like good Cholesterol. Variable expenses are directly proportional to sales. Higher the sales, higher the direct expense.
- Fixed Expenses or Overhead costs: These are the expenses which will always be there whether sales go up or down. They are fixed in nature and include Rent, Utilities, Leased equipment, management staff’s salary, Property tax, business insurance. This is like bad cholesterol you always want it low. You should always figure out ways to keep your fixed expenses low to keep profitability high.
Bottom-line, work hard to increase sales, keep COGS low, manage variable expenses in proportion to sale, keep fixed expenses low. It will result in high profit, which every business wants.