Profit and Loss Statement: Why Is It Important for Your Business
Starting a business and running it successfully is challenging. And one of the most challenging areas is accounting. So, if you are a new business owner hopelessly staring on your first profit-loss statement (P&L), then you are not alone. For business owners who do not have solid background in Accounting, understanding the profit and loss statement can be pretty difficult.
In fact, a lot of small businesses make the humongous mistake of not maintaining the P&L record in their beginning years. Well, worry not! In this article, we’ll decode what Profit and Loss Statement is, what is the actual meaning of those accounting jargon that you see on the statement and why it is super-critical for you to maintain the P&L statement.
So, let’s get started!
What is a Profit and Loss Statement?
Profit and Loss Statements or P&L Statements are also called income statement or revenue statement by many. As the name suggests, the statement gives you an overall picture of the net income of your business. So, how it is done? Simply, by subtracting all your expenses from the total revenue. The challenge here is to document all (I mean, ALL, no matter how small or big) your expenses and all your revenue. The bigger your operation is, the more number of vendors, employees or other spending avenues you have, the more complex the statement becomes.
So, How to Track Your Profit and Loss Statement?
Tracking your P&L statement is easier than you think! You simply have to keep track of all your expenditure as well as all your revenues. You can do this manually (it’ll be a humongous job though) or can use any accounting tool for the same. Whether you are using a tool or keeping track of things manually, entering correct information and ensuring that nothing gets skipped is of vital importance here
Why Profit and Loss Statement is Important for Your Business?
Well, it’s a legal mandate for one thing! As per U.S. business laws (and it is the same for most countries) it is required for every business (no matter how small) to maintain the P&L statement. But that’s not all.
A properly maintained P&L statement lets you track the progress of your business on monthly, quarterly or yearly basis. Simply by looking at the statement closely, you can assess the health of your business to a great extent. What are the areas where your business is spending a lot of money? What is your average deal size? Is there any areas where you can reduce the spending a bit? Which are the months when you have relatively lesser number of deals? All these questions can be answered by going through your P&L statement. And, if you are a business owner, you already know how crucial this insight is for the success of your business.
Another reason why having your income statement in place is crucial is for funding needs. Whether you are looking at expanding your operations or looking at purchasing a new office space, there are several instances when you may need a helping hand. However, when it comes to funding a business loan, all investors (traditional banks and peer to peer lenders alike) wants to know whether you are capable enough to repay the money. And, the first thing they’ll ask for to assess your profitability is the P&L statement.
So, Let’s Decode the Jargons
Jargons are what make accounting scary. If you are not from an accounting background then chances are you’ve stared at the acronyms without comprehension and ran a Google search on them. So, let’s decode the jargons that come with your P&L statement.
- Revenue: This is the total amount of money you’ve received in a particular time span. While it obviously includes the money you’ve made by selling your products and services, it also includes the money you’ve got as tax refund or the money you made by selling any property. In short, revenue is the sum total of money-in, from whichever avenue that may be.
- Expenditures: Again, no brainer! This is the sum total of everything that your business spends in any given time span. Remember, this includes all the money you’ve ever spent, no matter how small or big the amount in whatever avenue.
- COGS: This one stands for Cost of Goods Sold. Okay, so you might be selling a product for $10. But, how much are you spending to manufacture the product? COGS is the amount you send in making the product.
- Gross Margin: Subtract the COGS from total revenue and you get the Gross Margin.
- OPEX: This one represents all you operational expenditure; starting from the taxes and rents you pay till the salary of your employees and the logistical expense of sending the manufactured products to the shop.
- EBITDA: This one stands for earnings before interest, tax, depreciation, and amortization.
- Depreciation: Well, everything you purchase for your business, be it car or a machinery loses its value after a certain time. The lost value here is called depreciation.
- EBT: This stands for earnings before tax. Subtract COGS, OPEX and depreciation from your revenue and you get the EBT.
- Profit: Profit is the ‘bottom line’ of your business. This figure stands for how much money you are making after covering ALL your expenditure.
Now that you know all about that P&L statement, it is time to take a good look at it and see how you can maximize the profit for your business.