One main reason as why people set up businesses is they want to generate profits in the first place. Profits are essential for business growth and survival. They are key ingredients in creating savings for bigger projects in the future like expanding to a new location, increasing a product line, or opening up to another market.
Whether you have been in business for a while and are looking to see how well your business is faring, or are just starting your company and looking for more business material to guide you, one way to do so is to take a long, hard, look at your profit and loss statement. This is alternatively called Statement of Comprehensive Income or Income Statement.
This is the financial record that shows all the profits or losses that you have acquired or lost over the previous financial years. In business, financial records of previous years are used to analyze the efficacy of business operations in bringing in more money and are also used to guide business decisions. To learn more details about this critical financial tool, here is everything that you need to know about the Profit and Loss Statement.
What is This Record For?
A Profit and Loss Statement is a financial record that displays the total revenues collected over a period while comparing it to the total expenses incurred over that same period. By subtracting the expenses from the revenues, you are able to see the net earnings of your company, which may be a profit or a loss. If the revenues are great, you make profit but if expenses are higher, you create negative income and suffer a big loss instead.
Bear in mind, you can only get an accurate Income Statement if you are diligent with your accounting and bookkeeping practices. Otherwise, if there are missing data or dealing with erroneous data, you won’t get the full picture of your business. You may even make a mistake and believe there is profit when in reality, you have massive losses. Stop your business from losing money by staying aware of every detail in your operations.
Defining the Jargon for Better Understanding:
Let’s learn important jargon to help you understand concepts more clearly. Knowing the right details will help you secure your business’s financial health. These terms are:
Revenue comprises total sales. Revenues include:
– Sale of products and goods
– Service revenue
– Secondary business activities (bank interest)
Expenses are costs that go into the production and rendering of goods and services. Expenses include:
– Cost of goods sold or cost of service. These are the direct costs that go into making the product or rendering the service.
– Operating Expenses. These are indirect expenses that allow you to run your operations (rent, salaries payable, insurance, utilities)
Noteworthy, Tax expenses are also recorded on the profit and loss statement.
Profits are what you earn from the sale of goods or services. It occurs when your total sales are higher than your total expenses. Profits increase your business’ assets.
A loss occurs when your expenses are higher than your revenues. Losses decrease your company assets.
Analyzing the Profit and Loss Statement
There are different things that you can identify just with the Profit and Loss statement. Information in this financial statement is used to compute the Gross Profit and Net Profit Margin, as well as the return on investment.
- Gross Profit
The formula for gross profit is the total sales minus the total Cost of Goods sold.
- Gross Profit Margin
The gross profit margin represents the ratio of gross profits to the revenue. Its formula is the gross profit divided by sales revenue and multiplied by one hundred.
For example, if a company makes a revenue of 100 pesos and a gross profit of 50 pesos, 50 divided by 100 multiplied by 100 would yield a gross profit margin of 50%. This means that for each product sold by said company, it yields 50% of the sales price as a profit.
- Net Profit
Net profit is gross profit, minus operating expenses, minus tax payable and interest. This is also called the ‘real’ profit or what you earn after all expenses, including tax, are factored in.
- Net Profit Margin
The Net Profit Margin can be computed by dividing the net profit before tax, divided by the sales revenue, and multiplied by one hundred.
What Purpose Does This Information Serve?
The aforementioned margins can be used to guide business operations and decisions, including, but not limited to, pricing, cutting of losses, and advertising for increased sales.
The Profit and Loss Statement serves as a tool to identify how well your business has been performing. Moreover, when analyzed properly, it can also be a very good guide for business decisions so that you may move your company towards the future you desire for it to have.
If you are a business owner who wants to leverage this business and financial tool, you must stay on top of your accounting and bookkeeping practices. Failure to do so will result in inaccurate information that will affect your business decisions. For better outcomes, work with a CPA. Call our team for assistance and take advantage of our free 30-minute consultation.