Is Your Business Making Money?

Finance & Insurance

In my last blog post, we discovered how critical it is to practice good financial management in your business and the different reports you can get out of your accounting system to help you understand what is going on in your business.

The second part of our series of blog posts on ‘Understanding Your Numbers’ will demystify one of the reports required to understand your numbers – the profit and loss statement.

Basically the profit and loss statement is designed to tell you how well your business is performing over a set period of time such as over a month, quarter or entire year. This is the report that really drills down into details of what you’re spending and what you’re being paid for. The difference between these figures will tell you whether you’re actually making money out of your business.

Sales – Expenses = Profit

When the profit number is positive it means the business is profitable, a negative profit number means the business is running at a loss and a neutral profit number (NIL) means the business is breaking even.

The line items in a profit and loss statement include:

• Revenue (also known as income or sales) – includes the total dollar amount of revenue earned on sales of goods or services.
• Cost of Goods Sold (COGS) – includes the costs incurred in producing the actual product or service. For example in a manufacturing company the cost of raw materials or labour hours used to make the products is included.
• Gross Profit – is the difference between revenue and cost of goods sold.
• Expenses – this is made up of all costs to run the business such as sales and marketing, administration, staff salaries, rent, utilities etc.
• Net Profit – is the gross profit less expenses. This provides the overall profit figure and shows whether the business is profitable.

The best value is gained when you compare current profit against profit from previous years and budget.

This report should be monitored for:

• Changes in spending (is the telephone bill unusually high or have stationery costs gone up?)
• Changes in sales (have sales dropped compared to previous periods or budget?)
• Bookkeeping errors (does something not look quite right? Did someone miss a zero when entering an invoice or allocated it to the wrong expense category?)
• Declining profits (have expenses increased at a faster pace than sales?)

Next month we will continue our series of blog posts on understanding your numbers, where we will explore the balance sheet to discover what information it provides and how to interpret it.

Do you take the time to understand your profit and loss statement? If you do what have you learnt from it?  I would love to hear your thoughts!