There are 3 main financial measures that provide you, the business owner, with the financial health of your company:
- Profit and Loss
- Balance Sheet
- Cash Flow Statement
Today we are going to take a deeper look at the Profit and Loss, otherwise known as the Income Statement. In a nutshell, the Profit and Loss shows you if your business is making money or not. The Profit and Loss shows you the summary of your revenue or income in relation to your expenses over a period of time.
Your income for your business is the money you are making from your clients. You are charging your clients for a product or a service that your business provides. Maybe you are providing ski lessons and charging your clients for your expertise. Maybe you are making delicious cookies and selling cookies to your clients. Either way, the money you are generating is your income or otherwise known as your revenue.
On the flip side, your business is spending money. You have to purchase your raw materials or pay for software. Maybe you are buying chocolate chips for cookies. Maybe you need software so that clients can book a lesson. You will have insurance for your business. You might have utilities or rent. Perhaps you are paying for labor. Whatever those expenses might be, it is important to know what you are spending, especially in relation to your revenue.
Your net profit is the difference between your income/revenue and your expenses. Your business is profitable…in other words, you are MAKING money if your income is more than your expenses. This is where you want to be. On the other hand, you are at a LOSS if your expenses are more than your income. You won’t know if you are in that position unless you are keeping an accurate set of books.
As a business owner, you MUST know this about your business. You have to know if you are profitable or not in order to make decisions about your business.
The Profit and Loss is a measure of your business over time. We can look at your Profit and Loss for a month at a time, a quarter at a time, or for a full year. Larger periods of time give you important big-picture information. Smaller periods of time might show you that in April your expenses are very high compared to your income. Maybe you have software subscriptions that get renewed in April. Or you might see that in October your revenue drops. No one is skiing in October. Can you figure out how to make some passive income in October or offer specials for the upcoming season? Those types of analytics help you make changes or adjustments in your business so that you can cover seasonality or patterns.
Now let’s talk a little more in-depth about the types of revenue and expenses.
Categorize Revenue and Expenses
For a small business, the revenue is typically fairly easy to categorize. You might be an electrician so you are providing a service and selling parts. You can group all of your sales into one category and simply call it sales. Or you might want to break it into two categories:
- Sales of Product
This would give you additional detail about how your business is making money. These should be big-picture categories.
Expenses are a little more complicated because you need to categorize these based on tax rules in order to consider them deductions.
These categories can include items like:
- raw material costs
- cost of goods
These must be carefully categorized to fully take advantage of your allowed deductions…a topic for another day but just remember, categorizing your expenses will save you in taxes.
Remember, regardless of how many categories you have, your total INCOME/REVENUE minus your total EXPENSES will determine your profitability.
Make Good Business Decisions
In a nutshell, are you making money? Is your business in the red or in the black? I like to tell my clients, while you might love what you’re doing if you’re not making money, then this is just a hobby. You better REALLY love your hobby if you’re willing to lose money! It is important that you know if you are making money or not. If you’re losing money, you might throw in the towel and read a good book…
If you are making money, how can you maximize your revenue? How can you minimize the time you spend working in the business by hiring appropriately? How can you determine when you should buy that new piece of equipment your business needs?
Your profit and loss or income statement can help you steer your company into a path of success. Questions? Feel free to contact us!