A Newbie’s Guide to Profit and Loss Statement
The most intimidating and challenging aspect about business is always bookkeeping. Many entrepreneurs have brilliant ideas that they’re excited to put into action but hesitate to jump into it because of the prospect calculating costs and profits and having to keep an accounting of the money that goes out and comes in.
Every good entrepreneur knows that having a good understanding of your income statement is critical to the decisions you’re going to make for your company for the next few years. You have to know your business inside out.
Although most business owners agree that bookkeeping can be the most stressful part of doing business, they know that avoiding it can cause them huge problems later on.
Even with a competent and reliable accountant helping out with the books, you still have to be on top of your company’s finances. Business and finances go hand in hand.
The good news is that bookkeeping is really not as complicated as it sounds. All you need to do is to make yourself familiar with the terms commonly used.
The Basic equation is Sales-Costs = Profit
Sales minus Costs equals Profit is really all you need to remember. Everything else is just sub-calculations that only lead back to this simple equation.
The term “Sales” simply means income. This is the amount of money you earn from performing a sale or providing service to customers.
The costs are the expenses you have incurred to make the product available or to be able to provide the service. Other people call it expenditures.
The terms Costs, Expenses, Expenditures are one and the same thing on your income statement.
Profit refers to your net income. This is the money you earn after you have covered everything you spent on such as labor, suppliers and taxes, in providing the service or goods.
So if we take all those terms together, it will be like this:
The money you were paid (Sales) — how much you spent (Costs) = how much you earned (Profit).
By the way, the terms Profit & Loss statement and Income Statement mean the same thing.
Sub-division of costs
One of the things that can be confusing in an income statement are the sub-divisions of costs, but it’s really just a breakdown into categories of the things you spent on.
For example, you’re a company that sells watches. Your costs will be divided into the following categories: Cost of production materials, Cost of labor, Cost of utilities, and Cost of manpower.
All of these are subcategories under your Cost of goods sold or COGS.
If you’re a service-providing company such as a web development company, your costs may be subdivided into the following: Staff salary and Cost of Utilities such as electricity and internet usage.
These all goes under your Cost of Services or COS.
When you make the equation to calculate your profit, it will be:
Sales minus COGS/COS = Gross Profit or Gross Margin.
Your Gross Profit represents the money you earned from products or services you have delivered.
From your Gross Profit, you have to deduct your SG & A, which stands for Selling, General and Administrative Costs.
These are the expenses not included in your production costs but are necessary to keep your business running.
Your SG & A include your marketing and advertising costs — because you have to keep marketing your brand and your products and services to be able to reach clients and make a sale; it may also include Accounting Outsourcing fees, Legal fees and business loans.
Do it as you understand it
As you can see, you can start with preparing simpler Profit and Loss statements then later on, start breaking it down into details. It’s all really a matter of what makes sense to you.
The very thing you should be looking for is if your expenses are generating money for your business, then adjust or add from there. What’s important for you to know is where your money is going and if it’s achieving its goal.
Originally published at www.infinitaccounting.com.