Inside a Profit & Loss

Not everyone aspires to be in business and that is fine, but I feel like we can all do with understanding a bit more about how the numbers in a business work.

Businesses are constantly tracking a ‘Profit and loss’ statement whichs track their income, their expenses and, therefore, their profit.

They are taxed on the profit in some form.

You might think that reading a profit and loss (P&L) statement is like reading another language?

Don’t worry, you’re not alone.

We’re about to break it down in a way that’s simple and clear.

By the end of this lesson, you’ll understand exactly what you’re looking at, and more importantly, what it means for a business owner or even your own business.

Let’s dive in!

Firstly, what is a Profit and Loss Statement?

A P&L statement is like a financial report card for a business (or even your rental or side hustle).

It shows how much revenue came in, how much went out in expenses, and whether a business made a profit or loss over a certain period.

We had better start with Revenue and Expenses.

What the hell do you mean by revenue and expenses?

Revenue (aka Sales or Income)

Is the total amount of money that a business brings in. Think of it as all the dollars that flow into a bank account from customers or clients. Extra for experts - a loan isn’t a form of revenue.

Then there is the term Cost of Goods Sold Or (COGS)

This is what it costs to make or provide the product or service that the business sells. For a retail business, it’s the cost of the items they are selling. For a freelancer, it could be the external contractors needed to help deliver the work.

You may hear people talk about Gross Profit or GP. (Not to be confused with your doctor).

This is what is left after you take revenue and subtract COGS. In other words, it’s what the business earned before paying the day-to-day expenses.

Expenses - these are a simple one.

This is where we include all the costs of running the business that aren’t directly tied to making the product (think rent, internet, marketing, salaries, insurance etc.). Some people call these overheads or operating costs/expenses.

In the finance world they love to have multiple names for the same thing. I don’t know why!

Now the sexy stuff….Net Profit (aka the Bottom Line).

After subtracting expenses from the gross profit, we are left with the net profit. This is the final number, the total profit or loss for that period.

Like I said above, you may not run a business, but your employer WILL have to be thinking about all of the above. It’s worth understanding that this is how the real world works and the P&L makes a lot of decisions for a business. I.e. whether they can hire, fire, invest, market, survive or even cull a product/offering.

These days, many people think that sustainability is about fewer carbon emissions. BUT if a business isn’t financially sustainable, it’ll fall over and won’t be emitting any carbon nor paying any wages! Same goes for a rental or side hustle. You can't lose money forever.

Brutal but the reality of business. Profit drives a lot of decisions in a business.

Whether you’re running a small business, side hustle, or even just managing your household budget, understanding a P&L can give you powerful insights.

The same principles apply for a business and a household.

• Are you earning more than you’re spending?

• Do you need to cut back on certain expenses?

A P&L can help business owners (and you) spot trends and make better financial decisions.

Finally, let's look at an example. Take a look at the P&L statement below. I’ll break 2024 down for you:

Revenue: $1,265,910 (this could be from selling marketing services).

COGS: $304,931 (this is what it cost to produce the items sold, i.e. time).

Gross Profit: $960,979 (revenue minus your COGS).

*Expenses: $265,733 (rent, utilities, internet, legal, advertising, etc.).

Adjustments: $339,900 (payments to the directors as salaries)

Net Profit: $357,028 (this is the final profit after all expenses are paid).

*Those expenses are tax-deductible expenses to a business. Businesses can offset revenue with expenses and pay tax on the profit.

Now you will notice the yellow square - depreciation hasn’t been calculated in this example yet.

Depreciation is a non-cash expense that reflects the business's assets decreasing in value. This is a tax-deductible expense and also brings the profit down. It reflects the fact that an iPhone (or any asset) won’t hold its value, so the expense is the decrease in its value in that year.

Note to all the eagle-eye accountants, this example is made up and the tax amount doesn’t tie back to profit as there are further adjustments. This is just an example for teaching. Chill out!

Employee's - this is not a typical profit and loss for a business either. Not many businesses make a profit like this.

There you go, you’ve now got the basics of reading a P&L statement!

Remember, whether you're running a business or managing your household finances, knowing where your money’s coming from and where it’s going is key to financial success.

You could even try to make your own personal P&L statement.

Which is different from a cash flow statement….

Just when you thought you had nailed it, you learn there is another statement, because profit doesn’t always equal cash!

Accounting hey.

More on that another time,

Luke

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