The Myth of The P & L Statement

Napoleon Hill once said, “Money, without brains is always dangerous.” If you want to be truly successful in your business, the practical side of how money functions has to be discussed. It may not be as sexy or exciting as some other aspects of the entrepreneurial journey, but without it, you’ll find yourself fumbling as you grow, never really knowing if you’re winning or losing. I meet early stage entrepreneurs all the time who have a big vision, but if you ask them about the health of their business, they’re clueless. Typically, they don’t even know where to start to look. Even worse, some entrepreneurs treat their business like a personal checkbook. They see money in their account and spend it frivolously without knowing the economic or financial health of their company. 

There are ways to avoid that sort of negligence and be informed. The first component of knowing your numbers is creating a profit and loss statement. A profit and loss statement is super valuable. Hopefully you’ve all seen one. The top of the P&L (profit and loss) should show the income i.e. where all the money came from. After that, it starts to show your operating expenses and cost of goods sold. It goes through all the money that came in and went out. Then at the bottom, it shows either a positive or a negative number. Most people I meet who do have a P&L (even if it is something as simple as very basic QuickBooks P&L) will get that report, print it out, go right to the bottom and ask, “Am I positive or am I negative?” That’s their only barometer on how they’re doing.

It’s an understandable thing to do, but it’s an immature way to look at your P&L. Let me just share this with you, that number at the bottom of your P&L is a fantasy number. You can show a profit at the bottom line, but that doesn’t mean you really have any money. It doesn’t necessarily mean you made a profit. You may be in the black according to the bottom of your P&L, but that doesn’t mean that you have anything saved or have anything in the bank or have any tax earnings etc. Now, your P&L is useful if you’re booking things in a timely and accurate manner. It will give you a very good idea of where you are, but that bottom line is not something to hang your hat on. To be truly informed about your company’s financial health, I recommend you find an accountant or CPA who you can trust that has real experience working with businesses. 

After working on your P&L, you need to focus on your sales. Are your sales going up or down? Even if they’re going up or down, it doesn’t necessarily mean that you’re making more or less money. It means you’re converting prospects into customers at a certain rate. You need to pay attention to your cost for marketing. Take into account all your marketing endeavors including advertisements, speaking, trade show booths, social media strategy etc. Once you’ve noted all your marketing efforts you need to pay attention to how that converts into sales and customers. Ask yourself what your cost of customer acquisition is? How efficient are you at attracting leads, turning them into prospects, and then into customers. Also, if you have a renewable product, what’s your renewal rate? Do you have a high or low percentage of renewals? It’s essential to figure out how efficient your sales creation system is. 

Another important checkpoint for your financial health is continually checking your price points. You should be looking at your margins and deciding, “If it costs us this much to get the thing and this much to sell the thing, how much do we need to sell the thing for?” In other words, what’s your acquisition cost? What’s your cost of goods sold? Do you have commissions built into that? On top of that, you’ve got operating costs like your retail space or a website or human beings that you’re paying on payroll. Factor in all the costs associated with being in business, and ask yourself what price do I have to sell this product for in order to make a profit? When setting your price points remember to plan for the rainy days. What if all of sudden, sales stopped for a week or two, how would that affect you? Are your price points at the right spot where your profits could cover that eventuality? Will you always have cash flow to pay bills? 

Ask yourself, am I operating positively? Am I taking the best advantage of those gross margins? In other words, are you charging too much so you’re limiting the number of conversions in the sales or are you charging too little? Are you making a ton of sales but leaving a lot of money on the table? The other thing I really want you to pay attention to, if you sell physical goods, is inventory. Do you have enough money to cover the manufacturing phase (product creation, packaging, and shipping costs) while you wait for sales. What if that cycle lasts months? Does your price point cover that process? Do you have the cash on hand if you need it in order to afford your success? When you’re selling a physical product and especially if you’re having it manufactured somewhere, you’re almost always going to be operating in the negative while you’re growing. Then once you reach equilibrium, you’ll start to see the profits coming in. 

If you’re selling services, you don’t have that same issue. Basically, as soon as you provide the service, you have the money. At Laughlin Associates, we get paid in advance for a number of our services, but that does not mean it’s our money. In fact, when we’re doing something, we get paid for a year in advance, but we’re only able to book one month of service at a time. The rest of the money is seen as a liability. That’s unfulfilled work. That’s like saying somebody bought a pair of shoes and we can only send them the shoe laces this month. Therefore, we still owe them for all this other stuff that we’ve got to produce and deliver. The idea is that you need to comprehend how to book that money and cash flow.

Let’s talk about cash flow, it’s not just simply the money that’s progressing through your checking account. First of all, cash is king. Cash is the most important thing. The actual cash that you keep after all your expenses and taxes is the gold standard of whether you’re successful or not. You should have money that’s for your use or to reinvest in the business, to give to charity, to pay yourself more, or to invest in some new venture.

Cash flow is basically the number that’s computed by subtracting your operating expenses from the money your company generates during a normal day or month. Cash flow also includes depreciation of your net income. You’ve got to adjust for working capital and receivables and inventory cost. All that goes into determining your cash flow. When your operating cash (the money that’s inflowing) exceeds the outflow (the money going out to cover costs) then you’re in the black. If your inflow is greater than your outflow then you’re probably, not necessarily, in the red. It’s essential that you as a business owner make sure your company the necessary cash flow to meet all monthly expenses. 

Please remember, there has to be some predictability. You need to treat the revenues of the business like a real company would treat the revenue. A lot of times, small business owners will start to get clients, receivables and bring in money only to take money out of the business to pay themselves. They’ll take $500 here, $10,000 there and $1,500 there. They’ll start paying their bills like their cellphone or their car out of there. However, to keep your company’s financial health in check I need you to think about creating consistency with paying yourself so you can cover your own expenses out of your paycheck. Ask yourself, what can you predictably consistently pay yourself out of the business that you could take as payroll? Could you even use a payroll service? I know if you’re only one person paying $150 a month for a payroll service might seem excessive. I’m encouraging you to do it anyway. If you’re set up as a proper corporation or a proper multi member LLC then working with a payroll service is extremely useful. You will get a paycheck where taxes, social security, workman’s comp, FICA/FUTA, etc. is all being taken out. You will get a net check and you can show a pay stub that shows you’re acting like a real employee of the company.

Remember, you’re not the company and the company’s not you. Tell yourself, “I am not the corporation; the corporation is not me.” The only way to show that is to act like a real corporation. Part of that is to remember that you as a shareholder is different from you as an employee. You as an employee ought to be getting a paycheck. That paycheck ought to have taxes. You have an obligation to have payroll taxes and so on, which need to be deducted out of that and paid to the state.

I’ll tell you what, the fastest way to get yourself in trouble is to not be properly paying your payroll taxes to the state. Remember, money without brains is dangerous. Part of that is you’ve got to know the law. You’ve got to know the rules. You must follow them if you want to be safe and protected. Treat yourself like an employee. You have one job as shareholder, another job as director and then a different job as employee. Even if you’re the president, you’re still an employee of the company. If all this is freaking you out, I want you to remember an old quote that says, “Rich people constantly learn and grow. Poor people think they already know.” 

The truth is, this entrepreneurial journey is like walking through a minefield. I’ve seen so many companies get creamed because they just thought they could skirt around these basic issues. If you want to be in business, you must know and follow the rules. Sometimes it’s hard to do this stuff. Sometimes you think, “I’m having a hard time. I’m not doing stuff consistently. I’m struggling. I don’t have time to make a P&L because I’m just trying to get another sale. I’m working my butt off just to try to make a few bucks.” I’m telling you, when you learn the rules and you follow them, you will eventually have success. 

There’s so many people that do this like it’s a hobby. They’re the ones that always crash and burn. That doesn’t have to be you. Stay focused on your core business. Know what your numbers are. Follow them and be intelligent about how you deploy your actual real earnings. It’s not about the money flowing through the bank account, it’s about the money you get to keep as discretional money. When you understand that, pretty soon you will own the world.

Learn to be an Unshackled Owner @ https://aaronscottyoung.com/the-unshackled-owner/