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Business owners that understand their numbers are more profitable than those that don’t. Some business owners make decisions based on “gut feel” or the amount of money in the bank account. These decisions can prove to be toxic and detrimental to the business. It is important that businesses have accurate and timely financial data. Accurate and timely financial data starts with accurate bookkeeping.
So if you are a DIY bookkeeper or pay a bookkeeper it is important that you understand the structure of a Profit & Loss statement. The table below outlines the structure of a Profit & Loss Statement and highlights some differences between a product based business and a service based business. One sells goods and the other sells time.
Below are the key elements of a Profit & Loss Statement:
Product based business: sale of goods. Service based business: provision of services Product based business: products purchased for resale, freight, wages if goods are manufactured, merchant fees. Service based business: wages that directly relate to the provision of services, other consultants’ fees that are on charged to the client, printing that is on charged to the client.
Revenue the business generates. Revenue can be broken down by income streams to see trends. (Excludes interest income which is passive income).
Cost of Goods Sold (COGS)
Expenses that directly relate to producing the income.
Gross Profit (GP)
Income less cost of goods sold.
Expenses that relate to operating the business. Sometimes referred to as overheads. These expenses are generally constant and do not vary based on sales volume. They include rent, electricity, administration wages, travel, advertising etc.
Gross Profit less Operating Expenses (before interest and tax)
Non-operating income and expenses
Interest income and interest expense, depreciation, tax expense
Operating Profit less non-operating income and expenses.
Product based business: sale of goods.
Service based business: provision of services
Product based business: products purchased for resale, freight, wages if goods are manufactured, merchant fees.
Service based business: wages that directly relate to the provision of services, other consultants’ fees that are on charged to the client, printing that is on charged to the client.
Other abbreviations and terminology used when discussing a Profit & Loss Statement:
GP margin or GP%
Gross Profit percentage (gross profit/sales x 100%). This is the % margin and shows you how efficient your business is. Eg 30% – for each dollar of revenue you make 30 cents gross profit. If the GP margin decreases then you are making less money and need to understand what has changed in the business.
Earnings before interest and tax. Net profit add back interest expense, less interest income and tax.
Earnings before interest, tax, depreciation and amortisation. EBIT add back depreciation and amortisation. This removes factors that business owners have discretion over. Eg debt finance v equity funding.
NP margin or NP %
Net profit margin or percentage. Net profit /revenue x 100%. Eg 16% – for each dollar of income you are making 16 cents profit. If the NP margin decreases then you need to understand what has changed in the business. Eg, decrease in sales, increase in COGS or increase in operating expenses.
To drive profitability in your business:
We would love to help you set up and understand your Profit & Loss Statement so if you need help please book in for a 30 minute free consultation.