Profit and loss statements, or P&Ls, are essential financial reports for all businesses. The profit and loss statement is a proof of your business model because it shows how well your expenses and costs are covered by your revenues. The report also breaks down the company’s expenditures by category, such as cost of goods sold, salaries, rent, and marketing. By reading a profit and loss statement, you can clearly see how well your business is doing financially.
The benefits of creating and reading a profit and loss statement
There are many benefits to creating and reading a profit and loss statement. Some of the most important benefits are that a P&L can help you:
– Understand whether your business is making a profit or loss
– Identify which areas of your business need improvement
– Monitor your expenses and make sure they are aligned with your business goals
– Evaluate the effectiveness of your marketing campaigns
– Make better business decisions based on your financial data
Looking for relationships between expenses and revenues is one of the most important things you can do with a P&L beyond knowing your profitability. For example, food service businesses can look at the relationship between food costs and food sales. This ratio can be used as a benchmark for other periods or food service businesses.
How to read and understand your business’s profit and loss statement
When reading a profit and loss statement, it’s essential to understand what each section represents. The three main sections are revenue, expenses, and net income (profit or loss).
The revenue section shows how much the business has earned from its sales. This figure includes the money earned from selling items or services to customers and any returns and discounts. The expenses section shows how much the business has spent on its operations. This includes the cost of goods sold, salaries, rent, and marketing expenses. Finally, the net income (profit or loss) section shows whether the business made a profit or loss over the period covered by the statement.
It’s important to note these categories do not have anything to do with the amount of cash received or paid out. For example, sometimes you may sell your goods or services on account, payable in 30 days. All sales need to be counted as revenue in the period it was sold, not in the period the cash was received. This also goes for expenses. Sometimes you will purchase a good or service on account, and that expense or cost will need to be matched to the revenue that gives rise to the expense. This means you will record the expense when it occurs instead of when the cash is disbursed. Please check out our blog about The Difference Between Cash Flow and Profit to get an understanding of this concept.
It’s also important to look at the trends in each section. For example, if the revenue is increasing, but the expenses are increasing at a faster rate, then the business is making less profit. Or, if the net income is consistently positive, the business is doing well financially. By analyzing your profit and loss statement, you can make better decisions about how to grow your business.
A profit and loss statement is a crucial tool for any business to understand how it operates. By looking at how much revenue is earned along with the costs and expenses that give rise to that revenue, you can determine your profitability and observe trends between each period. This is important because it helps business owners and managers make strategic and tactical decisions for their business.
Please contact us if you want help understanding your profit and loss.