In business it’s important that you know how to read a Profit & Loss Statement, often called a P&L or ‘Income Statement’. Many business owners are not keeping a close eye on their business and from experience I know it’s sometimes because the reports are confusing.
So, let me make it nice and simple and help you understand this Profit & Loss Statement report.
Firstly, this report covers a period. It can be a single day, a week, a month, quarter or even year. In your accounting software, simply select the period you want to review. Often the first of the month to the last day of the month is a local choice.
At the top of your report will be your income. This is what you have invoiced exclusive of GST. In other words, your sales, or turnover. Let’s image for this article you are a small builder and your sales last month were $60,000.
Then your direct cost (or cost of sales, or cost of goods sold COGS) is listed. For a small builder that might be materials, sub-contractors, council fees. These are the costs that you will have if you have sales. If you have no sales, you would have no COGS or direct expenses. For each industry COGS can be different. For a trucking business it would make sense to have fuel as a COGS item, but for an accountant, this would be an overhead expense. So in this example, lets image the builder’s COGS was $35,000.
When you deduct the COGS from the sales, you are left with ‘gross profit’ in this case $25,000.
Now you will see a list of your overhead expenses. These are the costs of having a business, such as bank fees, advertising, office staff, rent, licenses, vehicle rego and insurance, telephone bills etc. Generally speaking, whether or not you have sales (or substantially less or more sales) the overhead costs will be present and usually quite consistent. For example your premises rent is the same whether you sell $1 or $1M. Sure, some things might go up if you sold $1M, such as your phone bill because it’s being used more. Now, interesting I mentioned advertising, BUT if you were a real estate agent, you might have advertising in two areas – the advertising you do for your vendors would be COGS, but your own business advertising would be an overhead expense. So, in this example, with our small builder, image the overhead expenses were $10,000.
When you take the gross profit ($25K) less overhead expenses ($10K) you are left with Net Profit, in this case $15,000. Net profit is often call ‘the bottom line’. That is of course profit before taxes, as your taxes are yet to be taken into account.
The last thing I thoroughly recommend is that if you have a bookkeeper or someone who does your bookkeeping, ensure you get a Profit & Loss Statement at the very least monthly. It’s fair to expect this by around the 15th of the following month. If they are months and months behind (or not forthwith at all), maybe it’s time to find a new bookkeeper. When you get this report, please really study it. If there is a single item on it which you don’t understand or thing is silly high or silly low, ask your bookkeeper. They can easily drill down into detailed reports and tell you how that figure is made up. Don’t be afraid to ask questions and query things!
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For How to Read a Balance Sheet, click here.