How well are you measuring the profitability of your small business with your financial statements?
Pat: I can speak every language but Greek.
Chris: Can you help me understand my profit and loss statements?
Pat: It’s Greek to me!
Well, I made these names gender neutral because in my experience, many of us ignore our financial realities. This is true for personal as well as business, but the consequences for financial ignorance in your business has a greater significance.
I know this is a dry and scary subject and some of you have already tuned out! Others of you are so on top of the situation that you may not feel the need to read further. However, if even one person out there decides to look at their profit and loss statement or work to better understand their financial situation, this blog will have served an important purpose.
If you think that, just because you can pay your bills and have a little extra to save or go on a small vacation each year, your business is profitable, you may be wrong. Cash in the bank is not necessarily the best indicator of profitability.
The best way to keep tabs on your cash flow is via a profit and loss statement. This is sometimes known as an income statement or a P&L that formidable spreadsheet-like mass of numbers that is about as appealing as lima bean flavored ice cream.
A profit and loss statement is a financial report that shows your income less your costs over a specific period of time usually a fiscal quarter or year. The resulting number is your net profit.
A simple profit and loss statement will include the following:
This is the total money taken in minus the costs of goods sold (COGS). COGS is the actual cost to you of the products you are selling.
This section includes, but is not limited to, accounting and legal fees, advertising, depreciation, utilities, rent, interest and bank charges, insurance, postage, printing and stationery, professional memberships and publications, training, vehicle operating costs, business travel expenses, repairs and maintenance, wages and salaries, billable labor, non-billable costs (e.g. marketing and sales) and worker’s compensation.
In addition, certain personal expenses may be included in your business costs as long as they are related to the business.
This is the total revenue minus total expenses. The resulting amount is your net profit before owner’s salary (BOS). Clearly, the importance of your profit and loss statement is to show if you are making money or not.
Tracking your income and expenses
You can use a simple Excel spreadsheet to track your income and expenses or you can use a software package such as QuickBooks. The key is to be consistent and persistent in maintaining this data. (Note: If the word spreadsheet nauseates you, it is time for you to hire a professional.)
A regular review of your P&L will help you stay on track with your business goals and will be invaluable when tax time rolls around.
Checking the pulse of your business
The ability to read trends over time is one of the greatest advantages of a Profit and Loss statement. Comparing statements month to month or even quarter to quarter can show the direction of your business and help you refine your business strategies. It is often helpful to track your Profit and Loss monthly, especially during the first couple of years. This helps you to note trends in the business and also gets you into the habit of staying on top of your business financial situation.
The more you know, the better you can anticipate and prepare for business spikes and/or slumps. Preparedness and planning helps you to understand the cyclical nature of your business (if any), and will ultimately put you into a position to make more money. And doesn’t THAT have a nice ring to it!