Understanding a P&L (Profit and Loss) Statement

The goal of this newsletter is to unpack what a P&L is and what the five P&L phrases mean. The P&L is the most common financial document that non-finance managers are exposed to.

Here's a very simplified sample P&L:

Revenue 100,000

Cost of Sales 60,000

Gross Profit 40,000

Operating expenses 25,000

Net Profit 15,000

Unfortunately, due to a lack of understanding of both financial jargon and accrual accounting, most non-finance managers struggle to read and make sense of a P&L. Many think a P&L is a cash flow statement - representing the money we received and the money we spent in a given period. That's NOT what a P&L is.

What is a P&L?

A P&L - profit and loss report - conveys whether a organization has made a profit or a loss over a given period. It lists the income earned during that period as well as the expenses incurred. The amount by which income exceeds expenses is called PROFIT. If, on the other hand expenses exceed income - there will be a LOSS.

Take a look at this short clip for more clarity:

Revenue

The revenue or sales figure on the P&L represents what we invoiced (billed) in the period being reported on. It's important to note that the revenue number represents that total amount invoiced to customers regardless of whether that customer has paid or not. The revenue number is not money received.

For more clarity on what qualifies as revenue and to understand how accrual accounting works, take a look at this short clip:

Cost of Sales

This represents the costs incurred to actually earn the revenue (make the sale). Cost of sales is a direct cost. This means that there will be a cost of sale triggered each time we make a sale. The cost of sale represents the cost price to us of making the sale. As per the P&L above the revenue earned was $100,000. The goods sold by our organization were sitting in our inventory at a cost of $60,000 and this is what we reflect as our cost of sales.

Gross Profit

This is a subtotal on the P&L. We deduct the cost of sales (also known as cost of goods sold) from the revenue to get the gross profit. The gross profit represents what is "left over" once a business has deducted direct costs from the revenue. The gross profit margin tells us what percentage of the revenue (sales) is gross profit and can be calculated as follows:

Gross Profit/Sales x 100 = 40,000/100,000 x 100 = 40%

Operating expenses

These are the costs necessary to run our organization - salaries, rent, utilities, insurance, telecoms etc.. These costs are unrelated to sales and will be incurred regardless of the revenue earned.

For more clarity on what qualifies as an expense and to understand expenses in light of accrual accounting, take a look at this clip:

Net Profit

This is the profit that remains after deducting operating expenses from the gross profit.

The net profit margin tells us what percentage of the revenue is net profit and can be calculated as follows:

Net Profit/Revenue x 100 = 15,000/100,000 x 100 = 15%

Essentially for every $1 in revenue (sales) after deducting all expenses, there is 15c left over.

If you understand what a P&L represents and what the terms on the P&L mean, you can begin diving deeper into P&L analysis and P&L management. More to come on these topics in a later edition.

Best,

Mark

PS. If you have non-finance teams that manage P&L's but struggle to understand and interpret them, we can help. Visit www.accountingmadeeasy.co or DM me for more info.