The profit and loss statement would probably be the most used report for businesses. It is easy to access and read and gives a pretty clear picture of the business health). So here is our take on the Profit and loss statement and how you can use this report to enhance your understanding of your business and make decisions.
1. Gross profit vs Net profit
The Profit and loss breaks down profit into two categories - gross profit and net profit.
Gross profit is the profit after removing the cost of making and selling products or the costs associated with providing services. The formula used is:
Gross profit = Revenue - Cost of goods sold
This includes materials, direct labor, sales commissions, credit card fees on customer purchases, equipment, utilities for the production site and shipping.
Gross profit doesn’t include fixed costs or costs that must be paid regardless of the level of output. For example, rent, advertising, insurance, salaries of employees not involved in the production and office supplies.
Net profit is the profit after both cost of goods sold (gross profit) and fixed costs have been subtracted from the revenue.
Try to look for ways to improve your profit margins. Look at what you are currently achieving and set some goals for improvement. Also try looking at your industry standards and set some goals that aim to improve your results against the industry averages.
2. Don’t just review annually
A business can be hard to manage if you only look at the previous 12 months. Firstly the data is old and might not reflect your current performance. Secondly, if you are going in the wrong direction, reviewing annually can mean that you aren’t acting quickly enough to make necessary improvements which can cause more damage. Instead try and review your Profit and loss statement monthly or at the very most quarterly. This means that you can catch any negative trends quickly, make the necessary changes and then review your progress.
3. Set some KPI’s
KPI’s or key performance indicators are a great way to measure your performance. We recommend using a net profit percentage as a starter. So this looks at how profitable the business is once the overheads have been removed from the gross profit.
Net profit: $100,000
Net Profit %: 100,000 divided by $400,000 = 0.25 x 100 = 25%
Looking at your net profit % can be useful, particularly if you have an increase in sales. If for instance your sales doubled you might think this was great and that the business was doing well. But what if the net profit % decreased? This formula allows you to measure how profitable the business is regardless of whether the sales have increased or decreased. On the flip side your sales might remain the same, but your net profit has increased because you have managed to reduce some of your expenses.
The devil is in the detail as they say, so sometimes there are small signs or opportunities within your reporting that may not be immediately obvious. It is always helpful to have your accountant view your Profit and loss statement regularly and provide input and advice.