How to read a profit and loss statement

If you are new to business you probably will not have had a lot to do with business financial statements. All that will change when you start your own business and you will need to gain an understanding of how a profit and loss statement is put together. Here is a quick guide to get you started:

The P&L statement measures all your income sources vs. all your business expenses for a given period. Let’s consider an apparel manufacturer as an example in outlining the major components of the P&L statement:

  • Sales:  This is the gross revenues generated from the sale of clothing less returns (cancellations) and allowances (reduction in price for discounts taken by customers).
  • Cost of goods sold:  This is the direct cost associated with manufacturing the clothing. These costs include materials used, direct labour, plant manager salaries, freight and other costs associated with operating a plant (i.e., utilities, equipment repairs, etc.).
  • Gross profit:  The gross profit represents the amount of direct profit associated with the actual manufacturing of the clothing. It is calculated as sales less the cost of goods sold.
  • Operating expenses:  These are the selling, general and administrative expenses that are necessary to run the business. Examples include office salaries, insurance, advertising, sales commissions and rent.
  • Depreciation:  Depreciation is worthy of special mention due to its unusual nature. Depreciation results when a company purchases a fixed asset and expenses it over the entire period of its planned use, not just in the year purchased. The IRD requires certain depreciation schedules to be followed for tax reasons. Depreciation is a non cash expense in that the cash flows out when the asset is purchased, but the cost is taken over a period of years depending on the type of asset.
  • Operating profit:  This is the amount of profit earned during the normal course of operations. It is computed by subtracting operating expenses from gross profit.
  • Other income and expenses:  Other income and expenses represent those items that do not occur during the normal course of operation. For instance, a clothing maker does not normally earn income from rental property or interest on investments, so these income sources are accounted for separately. Interest expense on debt is also included in this category. A net figure is computed by subtracting other expenses from other income.
  • Net profit before taxes:  This represents the amount of income earned by the business before paying taxes. It is computed by adding other income (or subtracting if other expenses exceed other income) to the operating profit.
  • Income taxes:  This is a provision for the amount of company tax to be paid.
  • Net profit after taxes:  This is the “bottom line” earnings of the business. It is computed by subtracting taxes paid from net profit before taxes.

The above article has been provided by the Small Business Company

Published on Friday, May 17th, 2013, under Latest News