How to Decode a Profit and Loss Statement
Confused by your profit and loss statement? If you don’t have a numbers background, the accounting jargon can be a little confusing at first. But once you learn the terminology, you’ll have a much better understanding of the information contained in these documents.
Profit and loss statements (also sometimes called P&L, income statements, or revenue statements) give you a nice picture of the net income of your business. That’s done by subtracting all of your expenses from the total revenue you bring in. The complexity of these statements varies by business. While a single consultant might have a very straightforward and simple statement, a restaurant with many employees, vendors, and expenses to record might have an extremely complex statement.
P&L statements can be generated to track income and expenses over any period of time. Most commonly, they are produced monthly, quarterly, and annually.
The Importance of Profit and Loss Statements
P&Ls are very important. In fact, most businesses are required by law to complete them. But aside from obeying the rules, profit and loss statements give you the opportunity to review your net income, which is essential for making sound business decisions. You will also need a profit and loss statement if you plan to apply for a small business loan.
Important P&L Terms
Revenue: Obviously, revenue includes the total sales that you make, but it also includes money you receive from things like selling property and equipment or receiving a refund on your taxes.
Expenditures: It’s not difficult to figure out what information is contained on the total expenditure line, but there are specific types of expenditures you may not be familiar with.
COGS: This stands for cost of goods sold. Even though you might sell a cup of coffee for $3, you don’t actually make $3 from the sale. You have to account for the cost of the materials and the time it takes to produce it.
OPEX: OPEX stands for operational expenditures. These expenses include any other costs associated with running your business that are not included in the cost of goods. For example: workers’ wages, travel, training, building leases, utilities, equipment purchase, hardware and software, advertising, cell phone and internet service. The list can get quite extensive, depending on the size and type of small business you operate.
Depreciation: You probably already know that if you drive a new car off the lot, it immediately loses some of its value. This is depreciation, and it doesn’t just apply to cars. Equipment, machinery and other business goods lose value over time as well, and this can be counted as a loss at tax time.
Profit: Profit is the proverbial “bottom line” on a profit and loss statement. It’s what’s left after you subtract all your expenses from your total revenue. And it’s probably the most important line for you. However, if you dig a little further, you’ll find there are actually different types of profit represented on your statement.
Gross Profit: This is the number you get when you subtract the cost of goods sold from your revenue. Business expenses like wages, utilities, rent, and more are paid from your business’s gross profit.
EBIT: This stands for earnings before interest and tax, and this number comes from subtracting both COGS and OPEX from your total revenue. The EBIT is a great indicator of business performance.
EBITDA: This acronym stands for earning before interest, tax, depreciation and amortization. While this line can also be good for measuring profitability, the fact that it includes non-cash items (depreciation and amortization) means it doesn’t seriously impact your cash flow in the moment. It’s still important to understand, but probably not as useful to you in the grand scheme of things.
Knowing these terms and understanding the insights they provide can help you operate a more profitable business. Read your profit and loss statement regularly for signs that you are on the right track or for warnings that you might need to make some changes. Compare and contrast your most recent statements with past statements for a better picture of your current standings and to help make informed decisions in the future.
If you would like to download a profit and loss statement click here.
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