How to read a Profit and Loss report
Way back when I started in business, I figured that if I was taking in money and only spending the money I had then I was in a profit situation, right?
After all, my accountant seemed happy.
Then accounting software took the world by storm and bookkeeping got easier.
At about that time I started working with McDonalds franchisees. Wow, these guys were really smart! They knew how to read a Profit and Loss (P&L) report; they drilled down into every line and actually used it to improve their business.
So what are the secrets that make it easy to read a P&L report?
Firstly, let me explain how P&Ls are put together; then we will talk about how to drive your P&L.
Anatomy of a Profit and Loss report
Generating a P&L report from your online accounting software is relatively straightforward. Use the help function to navigate your way through it. If you’re using MYOB Essentials, here’s a handy guide.
The first line is always your Sales, excluding GST. It’s the only place to start, because if you do not have sales you do not have a business.
Make sure you have your P&L report printed with a dollar figure as well as a percentage of sales figure beside each expenditure. This will make it easier for you to measure improvement later.
Cost of Goods Sold
The next section is the COGS or Cost of Goods Sold*. This is where you have recorded all purchases that relate directly to producing the sales in the first line, which are variable in nature. One example of this in a grocery business would be the packaging used to sell the product.
Don’t include things like electricity here, as they are an overhead and need to be paid regardless of whether you sell anything or not.
You can make this section as detailed or as simple as you like, but you should have as many lines as you have cost centres** in your business.
Next, simply take the COGS figure away from the sales figure, which gives you Gross Profit.
*This may also be referred to as Cost of Sales.
**These may also be referred to as Accounts or Account Codes.
Management controllable expenses
Expenses are the things that you, as an owner, have control over and can manage. This is where the real difference between a profit and loss occurs. Controlling these expenses makes you the better businessperson.
First, let’s look at labour. (This is usually the next highest cost component after COGS and a major area where you can improve profit.) Record the full cost of your labour, including the actual wages plus superannuation contributions.
You also need to record things such as maintenance and repairs, electricity, telephone and communication costs and outgoings.
After all the Management controllable expenses are taken from Gross Profit you have your Profit after Controllables.
In Other Operating Costs we have the costs that are generally set by leases or other agreements and are needed to run the business. This includes expenses such as rent, royalties, marketing, accounting and insurance.
Once you take these costs from Profit after Controllables you have Net Operational Profit.
How much have you got? Are you excited? This figure and all the figures above it are what you can compare with other businesses in the same industry.
These are all generally things that can be improved with good management, and this is where you will find all the dollars and cents that will add to your bottom line and go directly into your pocket. It is also the figure that builds the value of your business when you sell it, so it’s worth the effort to get this figure as high as you can.
Now all that is left to come off this operational profit are the things particular to your business, such as your finance costs and paying yourself (including your personal superannuation and income protection. What you take from here is up to you and varies from business to business).
Using P&L reports to improve your business
Every time you print a P&L report, print a column of percentages beside each expense line. This percentage figure is a percentage of sales.
To get these percentages it is a simple matter of ticking a box in your reports creator in your software. This percentage figure becomes your Key Performance Indicator (KPI) — which is something you can improve each and every day that you trade. KPIs are how those McDonalds franchisees really understood and drove their business.
Identify the KPI for each expense line in your current P&L report. Then set about improving it by just one or two percent. Share this new KPI with your staff and challenge them to meet it every day. This is how you work together to improve the business. When you next print out your P&L you will see decreases in expense lines. Each percentage point you can decrease your expenses puts money straight into your pocket.
Sure it takes time to get used to, but trust me, working with these KPIs each day takes as little as five minutes and gives you peace of mind that your business is on track. After all, all those McDonalds franchisees can’t be wrong.