A guide for small businesses
Analyzing periodically the profit and loss statement of one’s company is an essential part in managing expenses and can provide a clear picture if the company is operating efficiently. It can help assist in discovering issues with a company’s operations. Once the issues are discovered the analysis can prevent them from becoming larger and detrimental to the company. Such issues could be as crucial as high operating expenses or stagnant sales. The profit and loss statement can also show how expenses are contributing positively to sales. An example of this would be an increase in sales due to an increase in advertising.
The profit and loss statement is a report that shows a breakdown of revenue and expenses resulting in net income/loss as the ending number. The report represents a given period. It can be run monthly, quarterly, semi-annually or annually. It is required to be provided to the accountant for tax purposes, but it is also important to be reviewed periodically throughout the year. The items that one typically sees on a profit and loss are sales, cost of goods/services sold, gross profit, operating expenses, depreciation, net profit before taxes, income taxes and net profit after taxes.
Sales consist of the gross revenue produced by the company. Cost of goods or services sold represents the direct cost associated with selling the product or service. Gross profit is sales less cost of goods or services sold. It provides a clear depiction of how well the company is managing their expenses in relationship to making/providing the good/service. Operating expenses are costs indirectly linked to selling the company’s goods or services. It represents the selling, general and administrative expenses such as indirect labor, wages, insurance, advertising, sales commissions, rent and accounting and legal fees. Operating profit represents income during normal operations less operating expenses.
Depreciation is an expense that is the projection of the deterioration of a fixed asset. It typically is listed in operations expense or cost of goods sold. The depreciation balance that is listed in cost of goods sold is the cost that is directly linked to producing the product, such as a factory or production equipment. The depreciation that is indirectly linked to producing the product such as a car for a salesperson would be listed in operating expenses.
Other income and expenses are items that the company doesn’t typically incur under normal operations. Examples of this could be rental income, interest on investments, interest expense on debt, etc.
Net profit before taxes represents the company’s income before deducting taxes. Taxes aren’t assessed if the company is a proprietorship, limited liability company and a S corporation. For these types of institutions the taxes are reported on the owner’s personal returns. Net profit after taxes is the “bottom line” of the company’s earnings, which is calculated by subtracting taxes from net profit before taxes.
There are several reasons why it’s important to run and analyze the profit and loss statement for one’s company. One can review their profitability over time, compare performance to other companies or industry standards, compare one’s company’s actual profitability versus projected profitability, use past performance to project futures performance, and to provide proof of income to potential investors.
By: Andrea Tupper
