Profit and loss responsibility: What does it entail?
As a small business owner, you're responsible for your company's profit and loss. Here's how you can use that data.
In running your business, a task that can fall to the bottom of the to-do list is financial analysis, which reduces even the most vibrant enterprise to dry numbers.
Yet regular development and monitoring of your income statement, also known as a profit and loss statement, is a critical exercise in assessing your business's health and its footing for the future.
"If you don't know where you've been financially, you don't know where you're going," says former small business owner Barry Moltz, a speaker, author, and radio talk show host based in New Buffalo, Michigan.
Track profit and loss through the income statement
In short, the income statement starts with the amount of revenue or sales your company generates in any given period and subtracts the expenses incurred during the same period to determine the profit — or loss — achieved during that period.
From these figures, you can determine your gross profit margin, or ratio of revenue remaining after you've paid production costs. These costs could include materials and labor required to directly deliver goods or services, and are considered variable because they're based on rising or falling sales levels.
You can also calculate your net profit margin, or ratio of revenue remaining after you've paid all operating expenses. These costs may be fixed, such as rent, or variable, such as office expenses and advertising.
Ultimately, if either of these margins is too small or negative, your business isn't performing well financially.
"Your gross margin should be as high as possible because that represents how much of your revenue can be used to actually run the business beyond producing the goods or services," Moltz says. "As for expenses, a fixed cost is overhead that you should minimize. At the same time, try to make as many of your costs variable as possible."
A periodic review of all costs should help on both fronts, with a frank assessment of whether expenses that have long been fixed are more variable in nature. Prime candidates include annual contracts and retainers for professional service providers, such as accountants and attorneys who are only utilized a few times a year, and rent for storage space that is considerably underutilized most months.
Use the income statement to identify profit and loss trends
Past trends and future growth potential are essential to analyze your profit margins because if they remain too small or negative for too long, the path ahead indeed will be challenging.
Fortunately, you can use your income statement data to inform sales, expense, and profit projections — as long as you understand the factors behind your company's past results and use solid rationale for future estimates.
To that end, you might run profit and loss results covering two quarters and a full year on a quarterly basis — this may be accomplished through the company's bookkeeping software or accountant. When done over time, differences between reporting periods can illuminate positive and negative trends in sales and expenses. For example, if operating expenses are growing while revenues are declining, it's worth investigating further.
Start tracking profit and loss today
As a business owner, you're responsible for not only navigating day-to-day issues but also for planning for the future. To that end, an income statement that details how your business is actually covering costs and generating additional cash is a valuable tool to support your dreams of growth and your desire to build a cushion for the unknown.
Are you ready to create an income statement? Get started today.