How to read a P&L? There are two key ways a business can generate profits, one is by reducing the amount of money it loses in the form of costs and spending, and the other is by generating more revenue through sales. So in order to understand whether your business is profitable or not, it is essential that you know how to read your company’s profit and loss statement or ‘P&L’.
Without a P&L statement, it can be difficult for a founder to know the current financial situation of their company. So it goes without saying that while other financial reports are important for your business, a P&L statement is also useful in providing an insight into the financial stability of your firm. Now keep in mind that simply getting a P&L made is not going to be of much use if you don’t know how to read it.
With that said, a lot of new founders are not sure about the various components that are a part of a P&L statement, and therefore they fail to get the full benefit of their company’s P&L. Or are not clear on how sharing it will affect them. With that said, reading a P&L is not difficult, and with a little bit of effort, you can easily read and analyze your company’s profit and loss statement. So if you are an entrepreneur that is trying to analyze your company’s P&L statement, then keep reading, because this article will help you read and understand the P&L statement and get valuable insights from it.
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What is a P&L statement?
The Profit & Loss statement, which is also called an income statement, shows how much money a company made and how much it spent during a certain time. It shows exactly how much money a company made and how much it costs to make that money.
The revenue section shows how much money your business made during a specific time period. In the expenses section, you can see how much money you spent during the time period. You also list how much you spent in each category. It also takes your costs out of your total gross profit. The cost of making your products is subtracted from the revenue to show your gross profit.
The profit and loss statement, along with other important financial reports such as the cash flow statement and the balance sheet, can help you understand and improve your company’s financial situation.
Typically, a profit and loss statement is created when tax season arrives.
However, by producing a P&L statement once a month, three times a year, or once a year, business owners may review their profitability and compare different time periods to understand how their business has changed. This can help investors and banks determine how risky a company is before investing or lending money to it. It may also be used for insurance, compliance, and other things.
Who is responsible for creating a P&L report of the company?
Who makes a P&L report depends on how the company is set up. In most small companies, the P&L statement is often made with the involvement of the CEO, CFO, accounting staff, or outside CPAs and accounting firms. The P&L report is then given to other stakeholders of the company, such as investors. In larger companies with multiple divisions, different divisions may have their own accounting, which is the responsibility of the president of each division.
In this case, the presidents would turn in their P&Ls to the CEO, who might then put together an overall P&L statement for the whole company and show it to the board. In this way, the company can look at each division to see if it’s making money and if it’s helping the company reach its financial goals as a whole.
Keep in mind that in fundraising, storytelling is everything, and a P&L statement can give an overview of the company’s finances. In this regard, for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.
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Why every startup should create a P&L statement on a regular basis?
The P&L statement can help you look at trends in your business and figure out where you make money and where you lose it. Knowing how to read a P&L statement can help you in answering the following questions regarding your business:
- Is your business profitable?
- How are various income sources of your company doing?
- What does your business spend on?
- Are there any big costs that you might be able to cut back on?
Your income statement can show you the answers to these questions and help identify where you might have a problem. In addition to pointing out possible problems, the P&L statement can also point out chances for growth.
If one part of your business brings in a lot of money, you might want to put more money and time into that part to help it grow. On the other hand, if you have products or business lines that aren’t doing well, you can think about how to make them better or decide they aren’t a good fit for your business.
So considering the advantages that a P&L statement offers, it is a no-brainer that it is never too early to start creating a P&L statement for your startup. It is also just a good discipline to have, as you’ll be better prepared when you are asked for it. As far as reading and interpreting the statement is concerned, that is exactly what we will explain in the next section, so keep reading.
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What are the key sections of a P&L statement?
You now know the basics of how to read a P&L statement and why every startup should have this statement created at regular intervals. You are ready to start reading and interpreting it. In order to read this statement, you must first know the sections of a P&L statement and familiarize yourself with what each one means. With that said, here is a list of all the key components of a P&L statement:
To know if your business is profitable, you need to know how much money it brings in. You can use either a cash foundation or an accrual basis to figure this out. It will show how much money you made during the time period for which you created the P&L.
Cost of goods sold
COGS is the expenses that your business pays to manufacture the service or goods that you provide. This number includes costs such as supplies and shipping, although it does not include indirect expenditures.
Gross profit is the cost of goods sold subtracted from the total sales of a business. This doesn’t count costs like rent or maintenance, so it doesn’t give a full picture of your profits. However, it is a great way to get a rough idea about your company’s income.
Every company has to keep a check on its expenses, and a P&L statement allows them to do just that. There are generally two types of expenses that a P&L statement may contain, the first one being direct costs such as raw materials, salaries, and any other costs that are directly related to your product. The second type of expenses, called indirect expenses, are expenses that aren’t directly related to your product, such as transportation, maintenance of equipment and so on.
Operating profits indicate how lucrative your business is before factoring in items like taxes, depreciation, interest payments, and other external charges.
Interest costs are typically incurred when a business borrows money, whether through a loan, or another type of credit. Interest cost is the amount of interest paid to creditors over a given time period, as shown on your profit and loss statement.
Income before tax
This is how much money your business makes before paying income taxes. This metric shows exactly how much income is being generated by your business during a given time period without factoring in the income tax amount.
This section indicates how much of your company’s income is used to pay income taxes. By paying close attention to this figure, you can change your revenue goals so that you can easily handle income tax expenditures.
All of your costs are subtracted from your income to get your net profit. This shows how much money your business is left with once all the types of costs are taken care of. Net profit is usually what tells you the bigger picture about your company’s profitability and gives you a bird’s eye view of its financial situation.
This part should not be feared, but rather used to better your business. A loss indicates that your company’s expenses outweighed its profits. Essentially, this reveals how much money your company lost over this time period. It is not unusual for companies to make losses, and in most cases, these losses are easily recoverable as long as they are addressed in time.
These are all the most commonly found components of a P&L statement. While there may be some additional components in a profit and loss statement these terms are the ones you are most likely to encounter when resting a P&L statement.
Even as you’re learning how to read the P&L statement, you should also know how to present financials for a startup with no revenue. For more information, check out this video I have created.
Considerations when learning how to read a P&L statement
Pay close attention to the loss section
As mentioned above, the loss part of your P&L shows, if your earnings were more than your costs, or your costs were more than your earnings. Net profits are always something to be happy about, but a net loss doesn’t necessarily mean your business is in trouble; this is especially true when your business is just starting out. But it can show where you might need to pay more attention.
Compare your income and expense
Once you know if your business made money or incurred a loss, it’s a good idea to look more closely at your sources of income and how much you spent, and, more importantly, where you spent that money. Are your business goals in line with how you make money? Are you getting a one-off lucky surge in income numbers, or is it a gradual increase over several months or years?
It’s important to know if a rise in profits is due to gradual growth or a specific event or promotion. If your business had a net loss, you should see if you can cut any expenses.
Compare each new P&L with the previous ones
It’s important to know how to read a P&L statement and compare it to those from the past so you can see if your profit or loss is part of a pattern.
You can tell if you’re on track to reach your goals by looking at how different metrics improve or get worse with each P&L. After you’ve completed your comparisons, you’ll have a better understanding of what’s working and what isn’t for your company, as well as if you need to make any adjustments in the future.
Double check the calculations
If you’re using an Excel spreadsheet, be sure to check your calculations twice to make sure you didn’t miss anything or change a formula by accident. When you enter data manually to create a P&L, mistakes can happen that hurt your bottom line.
A P&L may seem like a simple document, but it packs a lot of punch in terms of the information it can provide you about your business. So, now that you know how to read a P&L, you can take the full advantage of this statement and use it to help your business expand and grow.
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