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.
A profit and loss statement, also referred to as an income statement, is a financial report 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 quarterly and annual basis, alongside a balance sheet and cash flow statement. It provides an easy way to gauge a company’s financial health and performance based on the net 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:
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 accounts receivables creates a more accurate reading on your financial position for that quarter or fiscal year.
These days, most large and small businesses rely on automated financial management software to develop their P&L statement. But if you don’t have one or simply wish to perform the process manually in Excel or Google Sheets, you can follow these steps:
Much of the information on the 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:
A P&L details the business’ total revenues, total expenses, and profits or losses for a specific period of time. These temporal constraints help you gain more actionable insights. Typically, an income statement is assessed over a month, quarter, or annual basis.
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.
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.
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.
This calculation leaves you with your 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).
Your next step is to calculate any interest payments, taxes, depreciation, and amortization expenses.
This will leave you with your net income and top-line growth.
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:
Your sales are the revenue 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 business profit. 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?”
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 net 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.
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 a company’s profitability since it accounts for non-operating factors.
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.
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 in charge of P&L management and 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?
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 integrates with your accounting software and provides your team with 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 overspending habits and better forecast your spend.
Sign up today to see how Ramp can drive your company’s P&L responsibility.