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How to Read Your Profit and Loss Statement

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How to Read Your Profit and Loss Statement

Wondering if you can afford to pay yourself more? Know you need to reduce spending to save more towards your goals, but not entirely sure where you can cut costs?

Or maybe you’re thinking about making a new hire or investing in a business coach. Can you afford to do that — or do you need to increase prices?

The answers to these questions and more lie in your profit and loss statement, or your P&L.

Why Your P&L Matters

I know you didn’t get into business to read and analyze a bunch of financial reports. So why am I telling you that it’s critical to not only know what your P&L is, but that you’ve got to learn to read it too?

Because it can seriously benefit you as an entrepreneur to get familiar with your profit and loss statements. It helps you stay informed and make better business decisions.

An accurate P&L report is also essential to determine your business tax liability, which is one of the best reasons to learn how to read it.

You don’t want to pay more in taxes than you have to — but you also don’t want to pay far less and end up facing fines and penalties.

But most importantly, knowing how to read these statements allows you to ensure it’s an accurate report. Again, you need your P&L to be correct because it can impact your tax liability and it will help you answer those pressing questions about where you can spend and where you should invest in your business.

It’s a necessary part of being a successful entrepreneur, and it helps ensure you’re doing the proper business planning to make the most of your profits.

What Your P&L Does for You

Your profit and loss statement is a document that summarizes your business’ gross revenues, total expenses, and net profit all in one place.

It gives you a big-picture overview that can provide insight into the health of your business, because it shows whether or not you generated a profit (yay!), or if you operated at a loss, meaning you’re spending more than you’re bringing in(yikes).

But if you’re thinking, “hold up. I don’t have a P&L report! I just have an income statement.”

…that’s okay, because we’re talking about the same thing.

Profit and loss statement (or report), P&L, income statement, earnings statement: there are a lot of names this document goes by, but they’re all talking about the same information about your business.

It doesn’t really matter what you call your P&L. It simply matters that you know how to read it and understand what it tells you.

How to Read a Profit and Loss Statement

Here’s the good news: your profit and loss statement is based on a really simple formula:

Sales – Costs = Profits

Let’s break that down together:

  • Sales means your gross revenue or income. It’s what your business earned before you had to pay for anything (or anyone) to run it.
  • Costs are your expenses. Expenses includes your direct and operating costs, any interest you paid or depreciation experienced, and taxes.
  • Profits represent your net income. In other words, it’s what’s left of your gross after all your costs are accounted for.

Pretty simple, right? The formula isn’t complicated. The tricky part of a P&L might come from breaking down these totals into subcategories and organizing them properly.

Knowing what to look for might not be so obvious, either. In general, most businesses look for signs of growth.

Savvy entrepreneurs also dig into the difference between revenues and net income and see how they might be able to make adjustments to their expenses in order to increase that bottom-line number and run a more profitable business.

Related: Your Guide to Employee Stock Options, RSUs, and Incentive Plans

Keep These Questions in Mind When Reviewing Your Report

As you review your P&L, here are some other questions you might want to think through:

  • How does revenue this year compare to the same time from last year? If you see a change in gross income, dig in and find out why. If you grew, can you pinpoint what allowed that to happen? If your revenues shrunk, do you know what changed?
  • How much am I bringing in after expenses? Most business owners like talking about their gross revenue — but that’s not actually what you took home. You need to know what’s left (especially for personal financial planning purposes).
  • What is my net compared to my gross? Again, it’s not enough to just consider what you grossed. You need to focus on your net and then compare that to your total to understand what your profit margin is. There could be room to grow that margin by reducing expenses.
  • What am I actually spending versus what I think I’m spending? Just as you need to review your personal budget to stay mindful of your finances, looking at your P&L can ensure you know what actually happens in your business. When it comes to money, business or personal, what we feel like doesn’t reflect what we end up doing.

Finally, consider your P&L report as a whole and ask yourself: is my spending realistic or sustainable if I want to pay myself more or invest in other areas?

A profit and loss statement can give you a lot of insight into the financial health of your business. It can also show you what may need to change if you want to stay on track to meet all your goals — both in your business, and in your personal life.

Want more insight on how to align your business finances with your personal goals? Schedule a consult here!

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