The primary role of a “profit and loss statement” is to show whether your company is profitable or not. It’s a financial document that every company should focus on, regardless of its niche, because it delivers important info when it comes to how the business is doing at that time. Learning how to read and understand the profit and loss statement can be challenging, but we are here to help you make sense of this document and better understand the outlined info!

What does the profit and loss statement show about your company?

While there are a variety of informational pieces (as we will show below), there are a few key elements that you’ll find in any P&L statement.

·       First, you will see if the business is turning a profit or if the expenses are higher when compared to the overall returns.

·       Additionally, you will see if costs are managed effectively or not. For example, your business might be 30% more profitable when compared to the previous year, but if the operational expenses are 60% higher, that means things are not as good as you expect. That’s why the profit and loss statement can be effective when it comes to identifying where you can start cutting some corners and alleviating expenses in an effort to turn a profit.

·       The profit and loss statement will also show you where the profits come from. The info is crucial because you can see what services/products deliver the most profits and which ones aren’t doing that well. You can start optimizing those offerings in order to boost profits.

How can you read the profit and loss statement?

The profit and loss statement will use specific formulas that will help showcase how your company is doing. The most important formulas are:

·       Gross Profit, which you can identify by subtracting the cost of sales (goods sold) from the net revenue.

·       Net profit or loss is identified by subtracting income taxes from net profit before taxes.

·       You can also identify the net profit before taxes when you add the net operating profit to other income while subtracting expenses.

·       Net operating profit can be found when you subtract operating expenses from your gross profit.

When you read the profit and loss statement, you also want to understand the meaning behind all those terms used as well. Each term will have a specific meaning while offering more insight into how the company is doing right now.

Net profit

Net profit shows the total amount that you earned once you removed any expenses. It’s a very good indicator of how much you sold during the year and whether your company was profitable or not. You can also see if the costs are elevated when compared to the previous year, too.

Gross profit

The gross profit can be identified when you check total sales and remove the costs of goods sold. As we mentioned below, COGS doesn’t include any overhead costs, just the inherent costs related to product/service creation and shipping.

Operating income

Operating income is the income you have before interest, depreciation, and taxes. The operating income is easy to identify; you take the gross profit and remove operating expenses from it. Accounting professionals call the operating income EBITDA (earnings before interest, taxes, depreciation and amortization). It’s a great metric that shows how well a business is performing because high operating income/earnings mean the company is doing well.

Sales revenue

Most profit and loss statements will start showing off the company’s revenue. It’s the metric that will help you figure out how many sales you generated, and you can easily compare it with the previous year, if possible. Usually, the sales revenue metric covers all sales generated from January 1st to December 31st unless the company operates under a different fiscal year style.

Cost of goods sold

Also known as COGS, this metric will help you identify how much it costs to create those products/services sold to your customers. An important aspect to consider is that COGS will only include direct expenses such as shipping costs, labor, raw materials, and so on. However, depending on the company, it can also include employee wages, online costs, etc. Rent, bank fees and utilities are not a part of the COGS.

Interest expense

Within the profit and loss statement, you can also find interest expenses as well. These appear on the P&L statement when the company has a credit card, a line of credit, or a loan. That’s when you need to make monthly payments with interest. Knowing how much you pay in interest every month/year is extremely important, and the P&L statement can help you track all the info.

Earnings before tax

Normally, the earnings before tax will account for a single line in the profit and loss statement. The primary role here is to show how much the company has earned right before paying any taxes. After that, you will usually have a line called “income tax expense,” where you show the income tax you have to pay. Depending on the P&L structure you use, you might find other tax-related details.

Other information included in the profit and loss statement

Aside from all of the above, the P&L might also include other info, like equipment expenses, marketing expenses, merchant fees/expenses, bank fees, rent, and so on.

Best things to focus on when reading a profit and loss statement

Since the profit and loss statement can be quite extensive, it’s a great idea to learn how to streamline the reading process. Usually, the main things you want to focus on include:

·       You should check the bottom line of the profit and loss statement since it will tell you whether your company is profitable or if your company is in the red. The statement also shows total expenses, so you can see what part of your business is not profitable. You can use such info to make the right adjustments and optimize profitability in the long term.

·       It’s also a very good idea to check the expenses and income streams. Doing so will help you figure out what expenses are very high and where you can start cutting some corners. Additionally, the P&L statement will help you narrow down the most profitable products/services, along with the less profitable ones. It’s a great idea to use this info in order to improve the less revenue-making products and boost their sales numbers in the future.

·       Another rule of thumb is to compare the current profit and loss statement with the one from previous years. You can see if there’s a trend or if this year was an anomaly. These comparisons can be effective since you can highlight an increase in expenses, what products sold more this year, but they also showcase areas for improvement.

·       Checking all data for complete accuracy is extremely important. That’s especially true if you use a spreadsheet. While errors rarely appear, it’s still a great idea to double and triple-check all the information, just to be safe.

Closing thoughts

We believe it’s very important to understand the structure of a profit and loss statement since it can highlight important stats and information about your business. Things like operating income, total/net income, sales, and cost of goods sold are crucial pieces of information that will help determine the profitability of your company. It’s imperative to check the latest profit and loss statement but also compare it with previous years. That way, it will become easier to identify anomalies or reoccurring problems and address them. In doing so, you can boost profitability and avoid issues in the long term!