You’re probably wondering if you’re making or losing money if you’re running a business. This will help you understand the path your business is currently taking, whether it’s on the right track or not. But the question is, how?
To determine how much money you’re making, you need to track how money flows in and out of your business within a specific period. This can be done with the help of one of the essential business financial documents—the profit and loss (P&L) statement.
The P&L statement is also known as an income statement. It is used for identifying how much money you’re making and how much money you’re spending. Your business is stable if your income within a specific period exceeds your expenses. Otherwise, you’re losing a lot.
Aside from that, you can use the statement as a guide when determining your working capital and formulating your budget. Regardless of its purpose, one must understand how one is prepared.
Below are the steps to create an operating profit and loss statement. But if you find this quite difficult, remember that you can always use accounting software or ask professional accountants for help and advice.
- Choose A Specific Timeframe
A P&L statement presents an overview of your company’s gains and losses within a specific timeframe. You can choose between monthly, quarterly, biannually, or annually.
If someone asks you for your P&L statement—for example, banks and third-party lending companies, they must state the period they want to examine. If they don’t, choose a timeframe to help you produce a reasonable and realistic trend without too much data.
- Determine Your Revenue
Now that you’ve chosen a specific period, the next thing you need to do is to determine your revenue within that timeframe. Revenue refers to the number of goods sold. An example of sold goods is the number of cakes and cupcakes or the amount of the rent you collected.
If you need a monthly P&L statement, list all the revenue you’ve collected in the previous month. But if you need a quarterly P&L statement, all you need to do is sum up all the revenue you received in the past three months.
- Determine Your Cost Of Goods Sold (COGS)
The cost of goods sold is crucial to every P&L statement. It is the amount you pay to produce and sell a specific product. Depending on the nature of your business, it may include raw materials, labor, manufacturer’s cost, and packaging.
For example, you’re running a pastry shop business selling chocolate chip cookies. To create cookies, you’ll need flour, baking powder, eggs, butter, chocolate chips, sugar, etc. The amount you spend to get those ingredients is your COGS.
Here’s a simple formula to determine your COGS:
COGS = purchases + (beginning inventory – ending inventory)
But if your business offers services instead of goods, you don’t need to compute for COGS but direct costs. For example, having a medical clinic is crucial for your operations if you’re a pediatrician. The costs of running that clinic, including electricity and rent, are your direct cost.
- Determine Your Gross Profit
Now that you know how much you spend to produce and sell your products and services, it’s time to compute your gross profit. You want your gross profit to be positive, not negative, to show that you’re making money from your offerings.
Here’s a simple formula to calculate your gross profit:
Gross profit = gross revenue – COGS or direct costs
After calculating your gross profit, the next to do is determine your gross margin as a percentage using the formula below. Try to achieve a higher gross margin as much as possible, indicating higher business efficiency.
Gross margin = [(gross revenue – COGS or direct cost) / gross revenue] * 100
- Determine Your Operating And Non-Operating Expenses
Operating expenses are necessary to produce a good or service, but they’re not a part of your direct costs. In other words, they’re indirect costs, as they don’t directly generate a product or a service, unlike ingredients and raw materials.
Below are some examples of operating expenses, but keep in mind that indirect costs may vary depending on the nature of your business.
- Basic utilities, such as electric and water consumption
- Internet consumption
- Office supplies
- Sales and marketing expenses
- Equipment maintenance and repairs
In simple terms, operating expenses are anything that can affect your daily business operations. But in most P&L statements, indirect costs are broken down into different categories. These include:
- Overhead Expenses – These are fixed costs you must pay when running a business. Some examples of fixed costs include internet plans, phone plans, and accounting software subscriptions. In short, these costs don’t fluctuate or change every month.
Depending on the nature of your business, overhead expenses can be other things, such as production costs. If you’re running a unique company, hiring an account may help you understand your overhead expenses.
- Administrative Expenses – These are expenses you must pay whether you produce a good or service. For example, if you’re running a spa, you must pay rental fees and other costs, even if you have no customers asking for your services. Some examples of administrative expenses are warehouse facilities and utilities.
- Non-Operating Expenses – These are the costs you rarely incur. These include business loan interests, legal fines, and tax penalties. Having them in your P&L is also essential to creating a more accurate statement.
- Calculate Your Net Income
This is the decisive moment you’ve been waiting for. Your net income will tell you if you’re making or losing money.
Here’s a simple formula to compute your net income:
Net income = gross profit – total expenses
Suppose your net income is positive, then rejoice! This means your business is financially stable and gradually growing. However, if it’s negative or breakeven, you might need to reassess and improve your practices. You might even need to reduce operating costs, look for cheaper suppliers, or downsize your company.
A profit and loss statement is one of the most important financial documents every business should have. It helps businesses understand how they’re doing, whether they’re gaining or losing money. If you need more help, consider hiring an accountant to provide a better and more accurate P&L statement.