#11: UNDERSTAND YOUR PROFIT & LOSS LIKE A BOSS

In this episode, I explain the importance of the Profit and Loss statement for small businesses. I’ll also cover its components, why it matters, and how to set realistic profit margin goals in your business. Common misconceptions/misunderstandings about this statement will also be addressed, as well as the optimal frequency for evaluating your P&L.

Key Topics:

·         What is a Profit and Loss statement?

·         Components of a P&L

·         Importance of setting profit margin goals

·         Common misconceptions about net profit

·         Actionable steps for regular P&L analysis

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Disclaimer: This content is for educational and informational purposes only. Please consult with an accounting professional for direct advice based on your specific business situation.

Transcript

Hi entrepreneurial friend! Welcome back if you've tuned in before. If you are new to me, I am Leslie Roth with Financially Adjusted and I am here to help you understand and navigate the financial aspects of running your small business. Today's episode is going to be a really good one and is designed to help you understand your profit and loss statement. It's one of the most important things you can learn in your business and will help you to keep your finger on the pulse of your business health. So, this is a very vital piece of knowledge to have.

We're going to touch on a few topics when it comes to a profit and loss statement. First I'll cover what it actually is and the components it's made up of. Then I will end by talking about the type of profit and loss statement you should be running in order to evaluate it and get the most out of that information for your business. So, let's dive right in. 

A profit and loss statement, otherwise known as an income statement, is  your income and expenses over a period of time. It's income minus expenses, which gives you a net profit or net loss, hence the name profit and loss statement. Income is also known as gross revenue and is the total money you brought in from selling products or services. Cost of goods sold are expenses that are directly related to the sales of your product or service and would be the first type of expense that is subtracted from your gross revenue.

Gross revenue can also be called your top line. Cost of goods sold is also known as COGS. That's how a lot of people refer to it. An example of cost of goods could be supplies and labor related to renovation products if you're a construction company, and this is a service provided. If you run a restaurant this would be food and beverage costs. By subtracting the cost of goods sold from your gross revenue or your top line, you are going to get gross profit or loss. From here, all other operational expenses are subtracted. You're then going to get your net operational profit or loss once you've subtracted those operational expenses.

So, we've kind of gone through the profit and loss statement from top to bottom so far or close to the bottom. So, you're going to have gross revenue at the top otherwise known as income or top line and then you're going to subtract your cost of goods sold which are directly correlated with the production of your service or product which is going to give you the gross profit or loss. Then you're going to get into your operational expenses. So, once we've subtracted those, you're going to end up getting your net operational profit or loss. 

It's important at this point to note that all revenue and expenses listed on the profit and loss are the main operational income and expenses. That's going to make up the bulk of your report.

At the bottom of your profit and loss statement is then going to be the other miscellaneous income and expenses that are added and subtracted. And it's important to note here that operational income and expenses are different from other income and expenses. So operational refers to the primary revenue generating activities of the business. And other income and expenses which is listed at the bottom of the profit and loss statement, is going to be anything else outside of normal operations for the company. For instance, if you're chiropractor and your main service is chiropractic adjustments, this is going to be listed as your main top line revenue. You might also sell some supplements on the side so you might end up seeing this listed at the bottom of your profit and loss as other income. Because it's just some miscellaneous income that doesn't make up your primary income source or your primary operational revenue generation. So, you might end up seeing that listed on the bottom as well as dividends from your bank account that are deposited every month. And those aren't part of your main revenue either so you would see those at the bottom. And as far as the other expenses or miscellaneous expenses that would be listed at the bottom of your P & L, you might see vehicle expenses down there if that's not part of your operational expenses. 

At the very bottom of the P and L, or profit and loss statement, you are going to see the net total profit or loss. That is also going to be called your bottom line. You’ve probably heard this mentioned quite a bit in the business world because it's a very important number and truly reflects the health of the business. The reason being is that at the end of the day, what matters is how much of your revenue you kept or how much margin you have in your business. You can have amazing revenue but still be operating at a loss which is absolutely not sustainable. And that can be the mark really of a business that's in danger of failing. You need to have margin in your business to succeed and to grow. This is why you absolutely need to know what your numbers are in your P & L throughout the year versus just annually at tax time. You need to be able to course correct if you're not profitable and analyze those expenses that are coming off of your top line throughout the month so that you can have time to course correct.

I really can't stress enough how important it is to analyze your profit and loss numbers every month in order to really know what the health of your business is. It's great to evaluate your gross revenue as well and compare it month to month but along with that you have to evaluate the whole picture. Which also includes what it's costing you to run your business and what you're left with to grow and take home. You can have amazing revenue and be making a million dollars each year but if your expenses are over a million dollars, you have a business that's not thriving unfortunately.

This is why I suggest having a bottom-line goal to drive towards. In other words what percentage of your revenue do you want to have leftover at the end of each month, each quarter, each year. In order to thrive in your business, you need to have enough profit that allows you to reinvest in your business, pay yourself, and pay off debt. You need to also know your net profit in order to know how much to save and pay for taxes, which is super important. I see that getting a lot of business owners in trouble where It's not really on your radar to save for taxes or pay in for taxes.

And then tax time comes, and you have that giant tax bill and you can easily remedy that throughout the year. Just pay attention to what your net profit is and set aside at least twenty five percent if not a third of your net profit every month into a tax fund that you do not touch. 

The percentage of your revenue that's leftover is also known as profit margin. I recommend having a goal, a profit margin goal of twenty percent at least, if you're a corporation.  If you are operating just as an LLC, then I think forty percent in profit margin or up is a good healthy number to strive towards as your minimum. The reason being is when you're an S-Corp, you are paying yourself on payroll which is considered an expense on the profit and loss statement.  You can also take distributions from net profit in that situation. But since you're getting a salary off that top line, your owner's pay is already partially accounted for. If you're an LLC, your owner's pay is only coming from draws or distributions. So you want more margin to be able to pay yourself as well as pay off debt if you have it, reinvest, or do whatever else you want with that money but you'll need a little bit more margin or profit margin on your P and L to be able to do all the things you need to do with it. I think having a profit margin goal sort of gamifies looking at your statements and can be really fun to evaluate your statements each month to see if you're meeting that goal.

Something I want to point out is that if you are running payroll for yourself and employees or both, you might have a month if you're like biweekly payroll. You might have a month that you have three payroll runs. And if that's the case, your line item your expense line item on your profit and loss statement for that month, is going to be much higher. So, your net profit goals for that month could really be affected because of that. So, you also tend to have as business owners quarterly bills and annual bills. So, by setting profit margin goals, quarterly, you're factoring in that there may be higher expenses in certain months and those things kind of wash out within the quarter. So, if you're comparing the quarter as a whole three months. So, let's say January, February, March, that's going to be a more realistic goal to look at or realistic numbers to look at. You should still definitely be evaluating on a monthly basis. But I would say stress more importance on looking at your profit margin quarterly.

Not only do I suggest focusing on your profit margin each month but I also recommend evaluating what percentage of your expenses are in comparison to your revenue. So, you're looking at that profit margin and you're looking at the total expense percentage. There is actually I'm talking about all these percentages and profit margin. There's a report that you're going to be running in your accounting software that allows you to view percentage of expenses and profit in comparison to your revenue. It should just be a menu option when you're running your report. I use QuickBooks Online exclusively, and they have a drop down menu titled ‘compare another period’, and you will end up checking the box that says percentage of income.

The percentages give you so much insight. Just looking at the numbers themselves don't necessarily help you to correlate how healthy the range of spending is but when you see a percentage, for certain expense items in comparison to your revenue, those numbers really can be put into perspective.

Each month when you're comparing from month to month it makes a lot more sense to look at the percentages. Not only can you set a profit margin goal, but you can also set a goal for each expense category, if you start analyzing your income and expenses against the goals you've set you will be absolutely amazed at how it can motivate you to strive harder towards your profit goals. Then if you start seeing your profit margin increase, that means you can leverage your it more for growth and paying yourself and hitting whatever goals you have in your business. Who doesn't want that

Next, I want to talk about something that is very misconstrued or misunderstood when comes to most business owners and their profit and loss statement. Something I see is that a lot of business owners take a look at that net profit that's on their profit and loss statement and they get really confused because they see that that is really not what they have in their bank account. The reason being for this is when you say do a budget, you are putting in all of your income and all of the money that is flowing out. So, you may have on there some payments to yourself in the form of draws you may have um, you know a payment to a loan and these types of things are actually not going to show up as expenses on your profit and loss statement. So, I think a common misconception is that would also be showing up on your profit and loss and subtracted from that top line revenue.

So, you have to look at that net profit number on your profit and loss statement and you need to remember, that number is not reflecting the amount of money you paid to yourself in the form of draws or principal portions of any loan payments. Those are not considered expenses. Those are actually considered balance sheet accounts and we'll get into that a little bit more next week when we talk about balance sheets. You can look at that number and subtract from there you know what you paid yourself, and any principal loan payments and that is going to give you more of a reflection of what is sitting in your bank account or what is actually the cash that's left over. So, I hope that helps to eliminate some of the confusion that exists around the net profit.

But if you have certain goals for each expensive category, you are really going to hone in more to all of your expenses every month and once you start analyzing your expenses in this way, you'll be looking for ways to get that number to go down because you've gamified it. It becomes kind of fun and you're benefiting and helping yourself in the process.

I hope this episode has given you the knowledge and inspiration you need to take a more active approach in managing the money in your business. It's definitely time to get off the sidelines if you haven't been doing this yet. And get into analyzing your numbers on a monthly basis. You'll hear me say this a lot if you're following me but no will ever care about your business and your numbers more than you do. So, if you have an outsource bookkeeper or tax professional who is taking care of your finances, don't just check out.

Make sure you are communicating with them and are having them help you to interpret your reports and understand them on a monthly or quarterly basis at minimum. You need to start taking responsibility for your livelihood and put in the effort to understand your financial health. 

I'm here for you and I know you're capable of doing this. Make sure you follow or subscribe to this podcast wherever you're listening and make sure you following me on social media because I'm always posting really great tips on there. That way you don't miss out on some knowledge and actionable steps that can help you win in your business. Also don't be shy about sharing the show with your entrepreneurial friends if you think they can benefit.

I appreciate you so much. Thank you for listening today and until next week, have a good one!

Disclaimer: This content is for educational and informational purposes only. Please consult with an accounting professional for direct advice based on your specific business situation.