Nothing can show a company’s profitability margin better than a Profit & Loss Report. This report is a financial statement that considers all revenues and expenses. It can help business owners cut losses, drive more revenue, and manage their profits more effectively.
Understanding the Profit & Loss Report will ensure you know how your company stands with its financial goals. Furthermore, you can get a good sense of particular changes you could make to improve the financial effectiveness of your business.
This article will show you how to read, understand, and extract valuable information from your Profit & Loss report to increase your company's performance.
Your Profit & Loss report contains information on your company’s income and expenses within a specific period. The report provides a detailed breakdown of these metrics and is more helpful if delivered frequently.
The two crucial points of this report are the top line, which is your revenue, and the bottom line, which represents your net profit. Essentially, the Profit & Loss report connects these two points.
Your Profit & Loss report will usually contain the following sections:
These metrics provide a clear overview of your business’s financial situation.
Revenue refers to the amount of money generated by sales. For nonprofits, this is the funds from fundraisers and donations.
Since this is an essential metric, many companies reference a detailed sales report that shows the performance of each department. You only include the final sales result on the Profit & Loss report.
Since you use revenue to make up expenses, this metric will determine the scope of your costs. If income is low, your expenses will need to be adjusted accordingly.
The cost of goods sold is the cost of manufacturing products or delivering services. This metric doesn’t include ongoing expenses like salaries or rent. Instead, it shows the cost of everything else that contributes to sales.
For a manufacturer, the cost of goods sold will apply to the materials used to create the product. On the other hand, for a retailer, this cost will be the price paid for the store’s products.
Some businesses might experience a small cost of goods sold. For example, services like consulting may have no direct cost whatsoever.
Your gross margin is the money left after deducting the cost of goods sold from the revenue. For example, if you have a product that sells for $10 and costs $4 to make, you’ll have a $6 gross margin.
A better way to represent this metric is to use a percentage. You can arrive at the precise gross margin percentage by dividing the gross margin by your revenue. From the previous example, this would be 6 / 10, equaling 0.6 or 60%.
A higher gross margin is good news for your business. It indicates that more money will go to your company from each sale.
Operating expenses include all costs necessary for your company to stay in business. These expenses include salaries, employee benefits, rent, research and development, marketing, and other costs.
You don’t include the cost of goods sold, taxes, or loan interests under operating expenses.
Your operating income is your profit before subtracting the interest, tax, depreciation, and amortization. This metric has another name from that very description — EBITDA.
You can easily calculate your operating income by subtracting your operating expenses from the gross margin.
Other expenses include interest, depreciation, amortization, and taxes. These categories don’t require an extensive explanation. Interest refers to payments made on account of any loans. Depreciation and amortization show an asset’s decline in value over time.
Your net profit, also called net earnings or income, is the final profit or loss after subtracting all expenses from your revenue.
A profit & loss report will likely be the responsibility of the company’s CFO or CEO. In larger organizations with separate divisions, each department might produce a profit & loss report. These reports are then compiled and presented as a complete overview of the company’s profits and losses.
If you want to create a profit & loss report, you can do so manually using one of two methods.
The first method is a simple calculation used primarily by small businesses in the service industry. This method doesn’t contain a detailed breakdown of a company’s financials, so it’s better suited for smaller enterprises. You subtract your total expenses from your revenue and gains. This gives you your net income, which will be the bottom line of your profit & loss report.
The second method separates the operating costs and revenue from other sections instead of focusing solely on the net income. This multi-step approach is a better fit for larger companies since it shows business financials in much greater detail and provides a breakdown by department. It includes calculating the gross profit, then the operating income, and, finally, the net income.
You’ll need to dedicate a considerable amount of time and effort to produce a detailed Profit & Loss report manually. Many companies find it more convenient to use specialized software or outsource the work to a professional accountant.
There are many benefits to understanding profit & loss reports. If your company produces regular reports, you can gain a powerful tool that will help you manage your finances better.
profit & loss reports give you insight into your company’s revenue stream and significant expenses. This information will allow you to understand your financial health and make necessary adjustments to your strategy based on your current needs.
All potential revenue improvements will become evident once you have all relevant information laid out. Also, you’ll get a clear idea of which expenses to reduce or cut to balance your finances.
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