Mind your P’s and L’s – Understanding your accounts

We all love profit. A business running at a profit is a successful one, right? Yet a surprising number of small business owners don’t know whether or not they actually have any profit at all. We can get so tied up with running the business, that we forget to check whether or not it’s actually bringing money through the door, and if so, how much.

Luckily, some clever business people came up with something you may already be familiar with: the ‘P&L’ or Profit and Loss Statement. Profit and Loss statements form part of your business financials along with the Trading Statement and Balance sheet they provide a comprehensive view of the business position at any given time.

However P&Ls on their own are simple yet extremely effective tool to see where your business stands in regard to income and expenditure.

Its simplicity comes from the fact that it divides your business into two absolutely objective columns: income and expenditures. Subtract the expenditures from your income and there it will be – in black (or red) and white – the sum total of all of your hard work, effort and cleverness.

Income Expenditures
Project $10,000 Wages $12,500
On-site $7,500 Rent $2,500
Recurring $5,000 Subscriptions $500
Services (Electricity, Internet) $300
Misc $800
Total $22,500 Total $16,600
Profit/Loss +$5,900

The above table looks pretty easy, doesn’t it? Well it is – you just need to get all of your income for a given period (let’s say a quarter), and all of your expenses for the same time frame, add them together, subtract one another and there you have it.

How can I use my P&L effectively?

Though extremely simple to put together, it doesn’t do anything by itself – it’s really there to help you to understand where your profits are coming from, where you need to put focus, and what expenses are just too much and need to be cut down.

The real trick to ensuring your business stays afloat is to follow these two simple steps::

  1. Commit to regular business performance reviews. Every quarter, lock yourself in your office for 15 minutes, draw up a P&L and make sure you understand where your business failings, successes and bottlenecks are. For example, if you have a ‘Holidays’ expense and it’s dragging your business into the red, you should be able to understand pretty quickly what your first cut should be.
  2. Draw up an action plan every quarter. Merely knowing where to focus or cut doesn’t get you anywhere – enacting change, and keeping your business flexible is what will really see it through the tough periods. If your P&L is telling you that your wage expenses are nearly outweighing your corresponding income, it’s either time to bring in more work, or cut down on staff hours (though be very careful when doing the latter).

But is a P&L really important?

If you’re not a registered company then you’re not obliged to produce one, though you’re not doing yourself any favours by not having one either.

  1. You will need to declare your income and expenses each year on your Tax Return anyway! You may as well draw up a quick table that you can analyse and reference.
  2. It will give you a quick summary of how your business is performing, and whether you have improved since last quarter/year/period.
  3. Consistent Profit and Loss statements are a vital part of your exit strategy. If you decide to sell your business in the future, potential buyers will often ask to see up to three years of financial reports which will include Profit and Loss reports. It looks all the more impressive if you’ve already done them.

At the end of the day, what we’re looking at is the health of your business. A P&L is a fantastic instrument for determining how best to improve the health of your business, but it’s up to you to assess the best way forward and enact appropriate changes.