Small Business Planning Pillar #6.1: Profit And Loss Statement (P&L)
Your Profit and Loss Statement (or forecast) pools together all income and costs that you have predicted in your small business planning process over, most commonly, a 3 year period. The difference between the two becomes your profit (or loss of course).
This bottom line is naturally a very important number to know.
After all, if you can’t turn a profit in you business then there’s no point having one.
However, your profit and loss statement can tell you so much more. By doing some very basic maths with some of the numbers you can build a set of indicators (a.k.a. “financial ratios”) which can then tell you at a glance what’s going on in your business.
And that’s the key. “At a glance” indicators. These small business health indicators must be in-your-face, not hidden away behind a wall of applied mathematics. I’ll show you some of the most important ones in a minute. But first of all, let’s take a look at a very basic profit and loss.
You can see that the P&L breaks down into three sections:
This brings together all revenues that you think will be earned by your business (with the possible exception of wayward stuff such as interest received on bank deposits and so on). In the example I have broken sales down into three subsections but this is entirely up to you, whatever you think works best. Don’t forget that the more detail you put in, the more information you can get out. The important thing is to find a balance between working your business and working your plan.
2. Direct costs (a.k.a. “Cost of Sales”)
Under this section you can summarise all costs associated with actually making your product. If you’re not sure if a cost is direct or not, ask yourself “would that cost still exist if I stopped producing my widget for a period of time?”
3. Overheads (a.k.a. “Fixed Costs”)
These are the fixed costs in your small business, i.e. they keep coming in relentlessly regardless of whether production is working or not. The items listed are pretty typical although you may find that yours looks a little different.
4 Useful Things Your Profit And Loss Statement Is Telling You
1. Gross Profit %:
Gross profit shows you how much profit you make from selling each item, without considering your overhead costs. i.e. If it costs £1.00 to buy a widget and I sell it for £1.50, my gross profit is £1.50 – £1.00 = £0.50.
If I then take this figure and treat it as a percentage of my total sales, I have then created a gross profit %. In this case, that would be £0.50 / £1.50 x 100 = 33%. In the case of the profit and loss statement shown above, my gross profit for Year 1 would be £250,000 – £125,000 = £125,000 and my gross profit percentage would be (£250,000-£125,000)/£250,000 x 100 = 50%.
Gross profit % helps you to benchmark your gross profit againstry industry norms and against your own ongoing performance. If you are a production start-up selling your own branded widget, you might be looking for 50-70% GP%. By contrast, a wholesale business may be happy with 10-15%. The key is to benchmark your GP% against industry standards which most approximate your situation. In the case of an innovative new product this may be tricky but not impossible.
2. Net Profit %:
Net profit shows you your company’s total profit after all operating costs are taken into consideration. Net profit % takes this figure as a percentage of total sales – a form which flags any imbalance in your overall P&L and allows target setting as your business grows.
For example, 15% net profit could be considered respectable, perhaps higher for a truly innovative, added value product. A net profit % of 3% might be acceptable in a low margin high volume business (e.g. wholesaling) but should flag to you that your business model has very little room for error if any of your costs change or if you have to reduce your prices at any stage.
In the example above, our Year 1 net profit is negative, ie losses so a net profit percentage would not be meaningful at this stage. In Year 2, our net profit % would be £7,000/£380,000 x 100 = 1.8%. Whilst this figure is low, we have managed to turn around our first year losses and would expect to see Year 3 approaching a more respectable figure, say 10-15%. Thereafter, we could set an increasing figure of 16%, 17%, 18% to challenge our business to continuously work more efficently.
For any one of your sales, direct cost or overhead categories, your can monitor the trend over time. Monitoring trends in your profit and loss statement is critical as this is your early warning sytem of something going wrong (or right of course). You would expect to see costs as a percentage of sales to decrease as your sales volumes increase. In other words, you are reaping the benefits of economies of scale as your business grows.
In our example, raw materials cost % in Year 1 is £40,000 / £250,000 x 100 = 16% and in Year 2 £48,500 / £380,000 x 100 = 13%, so an encouraging trend.
A glorious landmark in the development of your big idea. The day that you stop losing money and start making profits. Your Breakeven Point. This is a momentous occasion which should not pass without celebration, other than the fact that you will usually have gone past it well before your small business plannning process picks it up.
In the above example, breakeven occurs somewhere between Yr 1 and Yr 2. In reality, your first two years will probably record a monthly profit and loss statement so you will be able to see to more accuracy where your breakeven point exactly is.
Breakeven is a critical milestone for a number of reasons;
- You have proved that your big idea really can earn money. Now you’ve just got to wait and see how much.
- You will find life a lot easier. Easier to borrow money if needed, less sleepless nights, less pressure from shareholders.
- Most importantly, you should have developed two core strategies, a pre-breakeven strategy and post-breakeven strategy. The decisions you make and the timing of them will be quite different either side of this point.
……Small Business Planning Pillar #6.1: Profit And Loss Statement (P&L)