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Running your own business can be extremely challenging, with one of the most difficult aspects being accounting. Unfortunately, this is also something that many company directors fail to get a thorough grasp of. In fact, several small business owners make the mistake of believing that producing profit and loss statements (also known as P&L) are only helpful for larger organisations.
Understanding whether or not your company is viable is one of the most fundamental aspects of running a business. It is essential that you know how to maximise your profit and if your firm is heading in the right direction. While this may seem like you need to be a mathematics genius to understand, the reality is that profit and loss statements are an extremely simple way of gauging the health of your enterprise.
What is a Profit and Loss Statement?
Also referred to as the income statement, a profit and loss statement is one of the cornerstones of corporate financial analysis and reporting. It is designed to easily summarise the costs, revenue and expenses of the business, with the intent of giving the owners an insight into their firm’s ability to generate a profit.
The profit and loss statement is carried out by subtracting all of the company’s expenses from its total revenue. As a result, it is essential that business owners keep track of every single expense incurred by their firm and all of its revenue. The larger the operation, the more difficult this can be – which is why some companies use accounting software to help.
Analysing a Profit and Loss Statement
There are several key elements of a profit and loss statement that a business owner should understand. These include:
This represents the total sales or gross receipts that the company earned throughout the year. It basically provides company directors with a snapshot of the firm’s size and value. Once this has been worked out, the business owners can compare the results to the previous year’s statement to analyse the growth (or lack thereof) of the enterprise.
Any outgoings that are associated with the purchase or manufacturing of goods are known as direct expenses. Examples include utility bills, the purchase of raw materials, staff wages and any rent payments.
This refers to the profit generated from the sale of goods that will be used to pay the firm’s operating costs. Higher gross profits means that the business will have more money available to cover expenses such as rent, salaries and administrative charges.
All other operating costs that cannot be defined as direct costs fall under the umbrella of indirect expenses. These include interest depreciation, agent costs and advertisement.
Profit and loss accounts have two sides: the income part (credit side) and the expenditure part (debit side). The difference between the two sides is referred to as the net profit/loss. For example, if a firm has expenses of £1,000 and brings in £3,000, the net profit will be £2,000. The higher the firm’s net profit, the more effective it is at making money.
The Importance of Preparing Profit and Loss Statements
Now that you are aware of the basics of P&L, it is now time to understand the importance of preparing profit and loss statements. Keeping your accounts up to date will provide your business with a lot of important benefits that are crucial to the success of a company. Here are just a few:
The Ability to Make Informed Decisions
Having your company’s profit and loss statement to hand enables you to effortlessly review how the business fared over a particular period of time. Understanding exactly how the firm is doing in terms of revenue and expenses allows you to make much better financial decisions. As long as the numbers are not in the red, you will also be able to invest funds into the company.
A profit and loss statement will also enable you to answer questions such as whether the cost of selling your item is too great. If it is, perhaps you will be able to find efficiencies in the production process or your supply chain.
Proof of Success
Maintaining up to date profit and loss statements allows you to demonstrate how your business is doing during the course of its operations, giving you some powerful ammunition when negotiating with potential investors or buyers. It can also be useful when attempting to bring on new clients as it demonstrates that your firm is stable and can be relied upon.
Helps with Taxes
Regularly updating your profit and loss statements (as well as your other financial obligations) will give you all the information you need when the time comes to file your company taxes. Given the fact that some business owners struggle during tax season, having all the required details to hand will make the process a lot more straightforward.
Other Elements to Consider
As important as profit and loss statements are, they are not the only documents that small business owners need to pay attention to. For example, balance sheets will give you an idea of where you owe money and who your own debtors are, as well as where your money is tied up.
Another essential report to keep an eye on is your cash flow plan. As the name suggests, this will show you exactly where money is flowing in and out of your business – so you can see if you are needlessly haemorrhaging money or look for savings.
How Inquesta can Help
If you are looking to gain a thorough understanding of your company’s financial situation, you can rely on Inquesta to assist. We’ve helped firms from all areas of industry get to grips with their finances and we are perfectly placed to do the same for you.
We understand that no two companies are ever the same, which is why we will take the time to gain in-depth knowledge of your individual circumstances before recommending what we believe to be the right course of action for you. The Inquesta team specialises in all areas of financial management, from providing opinions on solvency and carrying out a review of your firm, right the way through to sourcing finance options and liquidation.
At Inquesta, we appreciate the stresses of running a business – meaning we are able to deal with any situation empathetically and with your best interests at heart. This gives you the peace of mind you need that everything will be taken care of.
For more information about how Inquesta can help you, contact our team today or request a free consultation.