When looking at a profit and loss statement, it’s tempting to jump right to the end to see the bottom line. After all, business owners want to see they’re receiving more money than they’re spending.
But every line of a profit and loss statement contributes to the overall story of your business. By taking a deeper look, you might see some detail you missed as it was happening. These insights can inspire real changes to increase profitability and tap into that next level of growth.
Here are our tips to maximize the value from your profit and loss statement.
Go Beyond Monthly or Quarterly Check-ins
A profit and loss statement (or P&L) is a summary of your revenues and expenses over a period of time. Commonly, business owners will look at P&L’s for individual months, quarters, or years. But business doesn’t always comply with a set schedule. So why limit yourself to just the usual periods of time when looking at your finances?
Maybe you want to measure the impact of a new employee or a newly released product. You can understand how these adjustments impacted your business by taking the time to generate a P&L.
When experimenting with how to grow and develop your business, consider your P&L a barometer of the financial success of your initiatives. These crucial financial statements provide you with all the information you need to understand how your business changed from a dollar and cents perspective.
Identify Your Fixed and Variable Costs
If you’re looking to increase profitability, you’re going to look at cutting costs. Looking through all of the expense types for something to trim can be dizzying. But understanding these expense types as fixed and variable costs can help you make a decision.
Fixed costs are the costs that you face every month regardless of how much or little business you conduct. Some examples of this are rent and salaried employees: it doesn’t matter how many sales you made, these costs are going to be the same. If you’re building out a budget for the new year, make sure you have the cash flow to cover these fixed costs.
Variable costs change with how much business is being done. Some examples of this are commissions and cost of goods sold: the more you sell, the higher these costs are going to be.
If you’re a newer business, start by looking to reduce fixed costs where possible. This will ensure you’re keeping your costs down as you find a balance in the amount of sales you’re making. But more established businesses with a higher volume of sales may want to look to variable costs first.
Pick out some expenses from your P&L and identify them as fixed or variable costs. Then, the next time you’re thinking of cost cutting, you’ll have a starting point of where to look.
Understand the Different Types of Profitability
There are three main measures of profitability you should know.
Net Profit
Net profit (aka “the bottom line”) shows a business’s profitability after every revenue and expense is taken into account. Consider this the full picture of your business, since it captures all business activity. It’s the perfect number to refer to to see how much your business is making at the end of the day.
Gross Profit
Gross profit looks at two numbers:
Sales revenue
You find your gross profit by subtracting your cost of goods sold from your sales revenue. This shows you how much money your business made on sales before you had any operating expenses like rent and utilities. Keeping a pulse on gross profit is important so you know how much money your business is generating to put towards those recurring operational costs.
Operating Profit
Operating profit is very similar to net profit except you exclude two costs from your calculation: interest expenses and taxes. While it may not seem like a big difference, there is still value to take from comparing your operating profit to your net profit.
Example: If you have a negative net profit but a positive operating profit, it’s time to start budgeting more for taxes. Or maybe look to refinance your debt to reduce your interest costs.
Start Thinking About Opportunity Cost
Opportunity cost can be simplified as every dollar you spend on something can’t be spent on something else. That is to say, the real cost of spending a dollar is the opportunity of spending it elsewhere.
If you need to spend more money to grow your business, or gain new efficiencies, you can either earn more or spend less elsewhere.
Look at your costs that are the easiest to change first. These costs will be the ones that aren’t essential to your business. A great example is any monthly subscription you’re not using. How often these days do we sign up for software solutions, then stop using it while continuing to be charged each month? These little monthly fees add up.
Thinking about opportunity cost will help you make decisions going forward. The next time you’re considering what to spend money on, frame it up as a sacrifice of all the other things that money can buy you. Maybe the return on a new office chair just isn’t worth it when compared to something like hiring a contractor to optimize your website.
Have Candid Conversations with an Expert
Staring at a P&L hoping to find some kind of answer or meaning will do you more harm than good. Instead, work with a trusted professional who can interpret the numbers and provide insights. A second set of eyes can make a major difference in the overall understanding of your business.
Even when business is booming, it’s important to be vulnerable and open about any concerns you might have, before thinking about them keeps you up at night. Plus these people will be supportive no matter what, there’s no question or concern you want to discuss they won’t want to help with.
If you’re thinking of bringing on professional help, outsourced controllership and CFO’s can help bridge the gap between where you are and where you’d like to be.
These types of specialists can draw from years of experience working with other businesses to identify potential growth and cost cutting opportunities you might not be able to recognize. They can even boost your financial mastery by introducing forecasting, providing you with a picture of where your business is headed. Learn more about how you can start getting the expert advice you need by booking with complimentary consultation today.