How to Develop and Analyze a P&L Statement
How to Develop and Analyze a P&L Statement: A Step-by-Step Guide
Staying on top of your company’s finances takes a concerted effort—and a lot of number crunching. Fortunately, most of the data can be handled by automated processes. However, those figures are still useless if you don’t know how to analyze them and then respond.
For instance, do you know how to analyze a P&L statement?
If not, don’t worry. Read on to find out everything you need to know, including:
- What is a profit and loss statement?
- How is the P&L developed?
- What should I look for in a P&L statement?
- What does P&L responsibility mean?
- How do you manage a P&L?
What Is a Profit and Loss Statement?
A profit and loss statement, also referred to as an income statement, is a financial statement document that summarizes your business’ revenue and expenses during a given period of time. It describes where your company’s resources are coming from and where they’re being spent over a specified time. And for increased clarity, it’s often broken down into fiscal quarters or even monthly periods.
A P&L statement is one of the three financial statements that every public company is required to issue on both a quarter and annual basis, alongside a balance sheet and cash flow statement. It provides an easy way to gauge a company’s performance based on the profits and losses the business generated.
According to Forbes, companies rely on comprehensive income statements to track their overall operations:
“[P&L reports] determine whether a company is profitable, and if so, by how much. Knowing how profitable their operations are in turn helps companies determine their tax liability. They can also monitor the rate at which sales are increasing or decreasing, enabling management to spot difficulties with a product or its market.”
To analyze your P&L, you’ll first need to determine whether you’re on a cash basis or accrual basis of accounting:
- Cash basis – Revenue and expenses are denoted by cash movement. So, if you agree to pay a service provider $1,000 next month, that $1,000 won’t be accounted for until it leaves your bank.
- Accrual basis – Both revenues and expenses are accounted for when they’re earned and incurred, instead of when they leave or reach the bank.
If you’re on a cash basis, you’ll have to consider unrecorded items as you go about preparing the P&L. Denoting soon-to-be payables and receivables creates a more accurate reading on your financial position for that quarter or year.
How is the P&L Developed?
These days, most businesses rely on automated software to develop their P&L statement. But if you don’t have one or simply wish to perform the process manually, you can follow these steps:
- Gather all your financial information and documentation – Much of the information on an income statement can be drawn from your cash flow statement and estimated calculations on depreciation. Your focus will be largely devoted to income and expenditure. That said, you’ll need three things: all the transactions in your business checking account and all purchases made on your business cards; all petty cash transactions or other cash transactions which you have receipts for; your income sources, including credit card payments, checks, cash payments—all of which can be found on your bank statement.
- Select your reporting period – A P&L details the business’ revenues, expenses, and profits or losses for a specific time period. These temporal constraints help you gain more actionable insights. Typically, an income statement is assessed over a month, quarter, or annual basis.
- Find your company’s revenue – List your business’ sales for the specified period. If you’re creating an annual income sheet, it’s helpful to break down net sales by quarter or month. Include your income sources, also broken up into smaller chunks.
- Subtract the cost of goods sold (COGS) to find gross profits – COGS are the direct costs of producing the goods or services sold by the company. By subtracting the cost of goods sold from revenue, you can find your gross profits.
- List your operating expenses – These can be broken down into specific categories such as Sales & Marketing (S&M), Research & Development (R&D), and General & Administrative (G&A). By adding these up, you can find your total operating expenses. Note: You could also separate by payroll expenses vs non-payroll expenses.
- Subtract total operating costs from gross profit – This calculation leaves you with your operating income.
- List your non-operating income – This could include interest revenues and gains on the sale of investments. After adding this to your operating profit, the total equals earnings before interest, taxes, depreciation, and amortization, also known as EBITDA. EBITDA = operating profit + (interest income + dividends earned)
- Calculate interest, taxes, depreciation, and amortization – Your next step is to calculate any interest payments, taxes, depreciation, and amortization expenses.
- Subtract interest, taxes, depreciation, and amortization from EBITDA – This will leave you with your net income.
What Should You Look for in a P&L Statement?
There are a lot of financial metrics contained within a P&L statement. Analyzing them may seem overwhelming at first, but to make things easier, it’s helpful to break it down by category:
- Sales – Your sales are the revenues generated from the sale of a product or service. This is the first metric you should be looking at, since increasing sales is the most simple way to increase your profitability. If there is a month that stands out, you must take the time to ask questions like, “what went right?” and “what factors drove sales, and how can we mimic that going forward?”
- Cost of goods sold (COGS) – Costs of goods sold are the expenses that are directly related to producing your goods or service. As you’d expect, these increase in accordance with revenue. Although it may be tricky, finding places to lower the cost of goods sold can also help increase your company’s profit margins. For example, you may be able to buy in bulk, embrace automation, or substitute lower cost materials where possible. That said, if cost savings reduce the quality of the product being sold, cuts may not be worthwhile.
- Earnings before tax (EBT) and EBITDA – EBT shows how much of an operating profit the business has realized before accounting for tax season. This figure makes it easier to compare the earning power of companies in different states with different tax rates. Earnings before interest, taxes, depreciation, and amortization (EBITDA), provides a short-term window into your operational efficiency. Many investors view this as the more important measure of profitability since it accounts for non-operating factors.
- Profit margins – Represented as net income as a percentage of sales, this is your bottom line. To calculate your profit margin, simply divide net income by net revenue and then multiply by 100 to convert it into a percentage. Once you’ve done this, you can see if your margins are up, down, or break-even.
What Does P&L Responsibility Mean?
If you’re the owner or an executive within a company, modeling profit and loss responsibility is one of your most critical roles. At its essence, P&L responsibility is all about considering ROI and then finding ways to maximize it.
Executives charged with this are expected to pursue new profit avenues, reduce budget expenditures, and ensure that every program within the company is generating positive ROI. As a result, they’re often the deciding factor in approving new projects or investments. According to Blue Steps:
“P&L responsibility involves monitoring the net income after expenses for a department or organization and influencing how company resources are allocated. Those with P&L responsibility often give final approval for new projects, find ways to cut budget expenditure, and ensure every program generates a positive ROI.”
So, how can you ensure that your company is embracing this mindset?
- It starts at the top – Leaders must set the example in communicating the importance of being conscious about company spend. The leaders in the company must model an ethos that ensures that every employee is doing their utmost to reduce costs and create a positive impact on the company’s finances. If those who have the most to gain from such behaviors fail to embrace this attitude, there’s little chance that mid-level and lower-level employees will.
- Take ownership of the good and the bad – It’s important that everyone in the business is accountable for both the business’ success as well as its failures. Top executives are expected to regularly report P&L statements to the business owners and shareholders. If mistakes do take place, they must be discussed openly and then troubleshot to avoid them going forward. Instead of pointing fingers and laying blame on others, it’s much better to create a culture where you identify mistakes, learn from them, and then modify your behavior. Similarly, achievements should be celebrated and then emulated.
- Be willing to take calculated risks – Mistakes or going in the red aren’t necessarily bad things, especially if they’re correctible or will generate more revenue down the line. What matters is that when an issue does happen, it’s addressed and then corrected. This ensures that your employees are operating in an environment that encourages them to push boundaries and innovate.
- Listen to others and encourage collaboration – A good idea can come from anyone, whether it be a high-level executive or a temp worker. If you want to drive your business forward and find new income streams, all levels of the organization must be actively involved in the conversation. By encouraging participation, you actively ensure that the company’s P&L responsibility is top of mind.
- Be open to bold ideas or new technologies – Practically every business has room for optimization, especially through automation. Instead of simply accepting the status quo, teams should investigate novel technologies or processes that could be employed to increase business profitability. For instance, processes like expense report reconciliation may often be conducted on a manual basis. For the accounting teams responsible for closing the books at the month’s end, this can be a frustrating, error-prone process that could be more speedily and accurately done via automation.
How Do You Manage a P&L?
P&L management starts with creating an income statement.
This gives you the ability to see gains, losses, identify trends, and find opportunities for cost savings. By creating a detailed and accurate P&L statement, you take greater ownership of your company’s profits and losses.
Once you have taken the steps to measure your profitability, the next question in P&L management becomes “how profitable could we actually be?”
Ways you can drive this efficiency include:
- Regular P&L statements – It’s critical that you continuously maintain detailed records of your company’s profits and losses so that you have better visibility and can produce accurate P&L statements every month or quarter. This gives you the ability to analyze where your money is going and whether it’s beneficial for the company’s financial health.
- Break up P&L statements – By breaking up your statements by department, it becomes much easier to identify areas where you could improve, make changes or cuts. You may have multiple departments that are providing solid ROI and one that’s dragging the rest of the organization down. It’s much more difficult to make savvy decisions from a high-level as opposed to a granular one.
- Compare your current P&L statement with past statements – The only way to measure gains or losses is by comparing it to different accounting periods. If you have improved, your job is to see what changed or why, and then determine how you can replicate that going forward.
Ramp: Driving P&L Responsibility
P&L statements are one of the three critical financial documents that you’ll regularly need to compile and then report on. They provide a window into your company’s financial performance and measure growth or losses over a specific accounting period.
If you want continued long-term success, simply producing P&L statements won’t cut it. You must also instill a P&L responsibility ethos from the top down. Fortunately, Ramp can help with that.
Ramp can provide your team real-time visibility and control over the expenses in your business. Whether you want a high-level view of the company’s spend or want to zoom in on a specific channel, with Ramp, you gain better management over spending habits and better forecast your spend.