Importance of Understanding the P&L

With a little extra time on my hands over this festive season, I have had the chance to catch up with some blog writing. You may have noticed that several of my recent posts focus on business planning and cost management. This is due to our current project, which we are assisting with cost management and business turnaround. During this process over the past months, I have noticed how little businesses genuinely understand their product, customer, strategy and, most importantly, their financials. In addition to the previous articles to assist restaurateurs and managers, I have written below a brief on how to understand the P&L in your restaurant and its importance.

Your Profit and Loss Statement can tell you much about how well your business is doing. Not enough emphasis can be given to the power of knowledge in any industry. Knowing your numbers will provide you with the ability to change the future. The real value is gaining insight into the actions and decisions that either yielded the profits or ended in losses.

Analysing the numbers allows you to tie specific actions that you might have deemed insignificant at the time to particular outcomes that impact the overall growth of your business. Your Profit and Loss Statement allows you to make operational changes in your business that will yield better results and positively affect your profitability.

The terms Income Statement and Profit and Loss Statement are interchangeable, but overall, they refer to the accounting of your revenues during a specific period. While your Balance Sheet shows the happenings at a given time, the Income Statement offers a quarterly, half-yearly or yearly summary.?

So, what exactly should you look for in your P & L statement, and how can it help you? The following terms and calculations will help you read your P & L statement and make targeted assessments about your profits, growth and spending mistakes:

1. Net Sales/Revenues

Net sales are the gross sales minus the sales returns, allowances, and discounts. Gross sales are the total sum of sales without adjusting the costs for goods sold, general and administrative expenses or any other costs.?

For example, let us assume that your restaurant made sales worth $500,000 a year. However, these sales would not accommodate any discounts or other expenses you may have incurred. So, if you offer discounts to senior citizens, school groups and through your customer loyalty programs, these costs must be adjusted before subtracting the sales discounts from the gross sales to get the correct deals for the year. So, if these discounts amounted to around $25,000 a year, then your net sales would be calculated by subtracting $25,000 from your gross sales (i.e. $500,000 or $500,000 - $25,000 = $4,75,000).

1. Gross Profit

Gross profit is the net sales minus the cost of goods sold. Gross profit refers to the overall profit you made after deducting all the costs of goods sold without deducting the operational expenses.?You can calculate gross profit by first calculating the prices of goods sold (COGS):

COGS = Beginning Inventory + Purchases – Ending Inventory

The inventory listed should include all purchases of food and beverages. For example, if you spent $50,000 on stocking the merchandise, only items worth $45,000 were used for the goods sold, and you still have $5,000 worth of inventory accumulated for future use, your COGS will be $45,000. And if you had net sales of, say, $1,10,000, your Gross Profit will be $1,10,000 - $45,000 = $65,000.?

The cost of Goods Sold has a significant impact on the profits of a business. It is essential for business owners to rightly stock the inventory to avoid shortages or wastage by overstocking the list with perishable items.

1. Income From Operations

Income from Operations is calculated by deducting the business’s operating expenses from its gross profit.?

1. Operating Profit Before Income Tax

Before-tax operating profit can be calculated by deducting the interest charges and interest income from the total income from operations. Businesses holding cash reserves in interest-bearing instruments like savings accounts and market funds will also gain interest from them. Add these interests to the business income and subtract any debts or outstanding bills to get the operating profit before tax.?

1. Payroll

Labor cost, or payroll, is one of the most essential expenses in your restaurant. Most of your business’s income has to go to salaries and hourly wages. Payroll is a controllable cost because the manager determines how many hourly employees to schedule and if the number of employees can be manipulated to save money. The trick is to cut down labour costs without compromising on the service you provide to your customers.

1. Operating Expenses

Operating expenses also come under controllable costs, including avoidable or adjustable costs like purchasing or replacing china, flatware or glassware, linens, paper products, etc. These costs will generally be noted under the operational expenses on your Profit and Loss Statement.

1. Occupancy Costs

Occupancy costs include rent or mortgage, property taxes, sewer and water taxes, gas and electric bills, insurance and repairs. These are known as fixed costs, as the owner has to pay a specific amount to cover these costs each month because there is almost no room for adjustments.

1. Prime Cost

Prime cost is the sum of the total sales and all payroll-related costs, including wages, benefits, payroll taxes, worker’s compensation and other related expenses. It is essential to closely check your prime cost as it represents the two most significant and most volatile cost areas, which comprise around 80-90% of your total controllable expenses. The excellent cost usually runs 60-65% of total sales in a full-service restaurant and around 55-60percent sales in a quick-service restaurant.

As a restaurateur, you should monitor your prime costs as frequently as possible. The sooner you learn about a problem with these costs, the sooner you can fix it. For instance, in case of payroll problems or liquor shrinkage, the more delayed your discoveries are, the higher they have already cost you in terms of profit. Generally, most restaurateurs check their prime costs once every month, which means they realise a problem 30 days too late.?

Restaurants that make higher profits keep closer checks, particularly on food and beverage costs. Ideally, you should check your prime price once every week; doing so will help you quickly understand and tackle the problem at hand. You should also make it a point to keep your kitchen staff in the habit of weekly reporting food costs; this way, they’d know they are being closely monitored. It’s widespread for restaurants to see at least 2-4% immediate lower food costs simply by keeping track.

1. Net Income

Once you have paid all your expenses, you are left with your net income, profit, bottom line, or earnings. This bottom line number is essential to assess how you fared in a specific period. Does it show growth or decline over your last year’s similar quarter? Determining whether your business is walking upwards or running downwards, and more importantly, the factors determining that trip, will help you better plan your strategies and cost management.?

So now that you know how to read your P & L Statement, it is time to give it a test run and see how you can make the profits bigger.