What is a Profit & Loss Account or Income Statement?
Most business owners and managers will understand what it means and would have seen a few in their time but some won’t understand what to look for and what it should really contain to make sense of how their business is performing.
A Profit & Loss account or P&L as commonly termed is a statement of revenues, costs and the resulting profits or losses for a given period and shows how well your business has performed during that period. The period could be a day, week, month or a year.
The best way to explain is to look at an Income Statement and see what additional analysis is required so that you can really see how the business is performing and whether your strategies are paying off.
As an example, I have extracted a recent quarterly Income Statement for Amazon (courtesy of Yahoo Finance) and shown some analysis of how to interpret the figures.
Just reading the figures as they stand doesn’t give the full picture and I have annotated what else should be included such as Gross Profit and Net Income margins.
For Amazon, the last quarter to December 2012 looks brilliant since revenues have increased by a massive 54% over the previous quarter. Probably because it was the holiday season and sales peaked. However, the gross profit margin reduced slightly from 25% to 24% and I am guessing that this is because they reduced unit prices to increase sales. This also shows up in the Net Income margin (after tax) being less at 0.5% of revenues as compared to the previous March 2012 quarter when it was nearly 1%.
One of the most important figures to look at are the Earnings before Interest, Depreciation (EBITDA) and on this formal Income Statement, only the EBIT is shown and again by dividing the figure by the revenues, it shows that Amazon’s last quarter has the highest EBIT margin at 1.7% compared to the next highest quarter of 1.2%.
By having these simple ratios shown in your business P&L, it is easy to spot trends and problems and indeed most of these can be highlighted through charts which are easy on the eye. The other comparisons to have are your rolling forecasts or budgets for the reporting periods and also industry competitors margins and figures so that you can benchmark your business performance.
In summary, the key figures you need for your P&L are:
1. Revenue trends – are the sales improving and by how much
2. Gross Profit margins – are they improving and how do you compare to the competition and can you afford to reduce prices to gain market share
3. Earnings (EBITDA) – are they better than the competition and if not why
4. Net Profit margins – are they better than the competition
5. Comparatives – compare to budget/rolling forecast/competition and also the best performing period you had
The above can be extended to all elements in the P&L such as categories of expenditure and income by customer etc. Figures alone won’t tell the story, so to have a short punchy commentary with your monthly accounts would highlight the key areas that you need to address or improve.
Also reading the P&L in isolation is not advisable and the Balance Sheet and Cash Flow Statement have to be read in conjunction to make any sense of the overall business performance. I’ll do guides to the Balance Sheet and Cash Flow later.
Meanwhile, do you get a detailed analysis of your business performance in your P&L?