Understanding Your Profit and Loss Statement

Your profit and loss statement (P&L) helps you understand your business performance and profitability over time. It’s sometimes called an income statement, which mainly lists income and expenditures.

A balance sheet is a time snapshot, while a P&L shows transactions over a specific period. This can be a month, quarter, financial year or any other period, and it can be a stand-alone or comparative period report.

Together with the balance sheet, these two reports provide a comprehensive understanding of a business's financial position and performance.

The profit and loss statement has two main sections: income and expenses.

These may be further subdivided depending on the complexity of the business and reporting requirements.

Income or Revenue

Income primarily includes income from main business activities such as selling goods or services. Other income, such as interest received, capital gains, or income from secondary business activities, is also reported.

Expenses

Expenses are usually divided into direct costs, or cost of goods sold, and expenses. The cost of goods is directly linked to the provision of services or the sale of goods. For example, if you buy widgets from a wholesaler and sell them at a marked-up value, the cost of the widgets is a direct cost, not an overhead expense.

Other direct costs might include importing, freight, contractor, or specific equipment costs. Some direct costs are fixed, that is, they are the same from month to month or could be a fixed percentage of sales; others vary in value but are still related to income-producing activities.

Overhead expenses are all the other expenses required to run the business, regardless of the level of income: for example, rent, utilities, bank fees, bookkeeping fees, professional development costs, vehicle costs and staff costs. Many of these costs form the basis of working out your break-even point, or how much it costs to open the doors for business.

Some expenses, such as merchant fees or contractor costs, may be reported as direct costs in one business but indirect costs in another.

The Bottom Line

Total income minus total expenses results in net profit (or loss), which is often called ‘the bottom line’. Usually, business owners are just interested in the bottom line. Still, an accurate financial picture requires an understanding of several reports and an ability to see the big picture that the reports illustrate.

The P&L is a vital tool to analyse trends over time.

• What does your P&L tell you about relationships and ratios between sales and expenses, seasonal changes and annual trends?
• Have all your direct costs been allocated correctly?
• Have you recouped all billable expenses from customers?

Financial statements help you see the big picture for your business.

Contact us to understand your operations and performance better so you can make informed decisions about your business finances.