Raise your hand if you’re better at making paper airplanes out of financial reports than reading them. You’re in good company! An Intuit study in 2014 found that 66% of small business owners wish they understood more about their finances. Today, we’re going to make sure that you’re in the minority and ready to take your biz to the next level!
Last week, we discussed how important it is that you use financial reports as a roadmap for your business. This week, we’re going to take a deep dive into how to read a Profit & Loss Report (also called an Income Statement), so that you know what you’re looking at. More importantly, I want you to know how to use the Profit & Loss report to steer your business towards growth & profitability. Ready? Here we go!
What does a Profit & Loss Report tell you? The Profit & Loss Report is where you find out how much money your business has earned in a given time period, how much you have spent and whether your business made a profit or not.
Throughout this post, I’m going to refer to the Profit & Loss Report for Craig’s Design and Landscaping Services from QuickBooks Online, their Sample Company. (Did you know that you can test drive QBO?? Comment below if you’d like the link for this sample company account!)
Starting at the top of the Report, you should find a total for Sales or Total Income ($4,736.21 in the screenshot above). Review your sales and compare the total against the targets that you’ve set in your goals for the year. Your sales may be lower than expected for many reasons. You may have sold fewer projects than you expected or you may have sold as many projects as you expected but at a lower dollar average. Sometimes a fewer number of high dollar projects will make for a better month overall than several small dollar projects. Look at your mix and figure out what works best for you and your business. Most importantly, you should be able to explain why your sales are higher or lower than expected. In our example, June has turned out to be a much better month than May was! Hopefully Craig knows why it was a good month and can repeat that successful mix going forward.
Next, look at your Expenses. Are they up or down over last month? Sales are not always under your control and how many dollars are coming in during a given month are often dictated by how quickly your clients pay their invoices. What is easier to control, however, are your outgoing expenses. Compare each expense line item, such as Advertising Expense, against your previous month’s total for that expense and also compare it against your expense targets. It makes sense, for example, that a killer month in sales may also show a significant rise in the Advertising Expenses required to produce that boost in sales. Once again, you should be able to explain each expense line and why that expense was important for your business.
Review each of these line items and determine if each expense was in line with expectations. An unexpectedly high number in one of these expense categories is your early warning system to try to reduce expenses or shift costs so the bottom line profit is where you need it to be. In our screenshot, Insurance and Utilities both jumped a bit since last month. If you pay your entire Liability Insurance premium at once, then a big number in the month you paid it makes sense. What about Utilities, though? Can you explain the jump in this number? Should you look for a cheaper telephone plan? Understand your numbers and use them to help keep expenses under control!
The Net Income line is perhaps the most important number on the Profit & Loss Report. For a sole proprietor, the Net Income represents your take-home pay. Is this enough for you to live on? Is this enough to pay back any loans that your business may have? If not, you only have a few options: bump up Total Income or cut Expenses. Trust me, there is only so far that you can cut Expenses and still keep your business running. There are a million options for increasing your Income, though. Continue to tweak your service mix until you can get your Income totals where you need them to be.
Calculating your net profit margin is particularly helpful if you want to compare how your firm is doing against your peers. In the example above, take $814.57 and divide by $4,736.21 to arrive at a Net profit margin of 17%. It might take a little digging, but you should be able to find the average Net Profit Margin for your type of business. For landscaping companies, the net profit margin should be between 10% and 20%, depending on the mix of maintenance versus installations and commercial versus residential. Compared to those averages, our Craig’s Landscaping company is doing well!
Last, but certainly not least, you want to make these reports a part of your monthly routine. Each month, close out your books, reconcile your accounts and run your Profit & Loss Report. Use this report as a report card for your business to see how well you’ve done. If you’re below your targets, what can you tweak to improve next month’s numbers? If you did better than expected, how did you do it and can you do it again next month? Only you can decide your ideal mix of volume, pricing and expenses that end in a tidy Net Profit each month.
Now you know how to read a Profit & Loss Report! Pat yourself on the back with the knowledge that you’re now ready to steer your small business towards better profitability and the next level of business growth. Congratulations!
Have a question on how to read your Profit & Loss Report? Leave a question below.
Don’t forget to come back next week for a deep dive into reading the Balance Sheet. Trust me, it’s not as boring as it seems!
Deb Howard Greenleaf, EA, CEO and Principal, of Greenleaf Accounting Services provides virtual accounting and bookkeeping services and specializes in financial management to consultants, coaches, solo professionals, and other small business owners across the US. Deb is an Enrolled Agent (EA)—an IRS-licensed tax professional—and specializes in small businesses and entrepreneurs filing Schedule C or as an LLC. As an Advanced Certified QuickBooks ProAdvisor, Deb spends her day in QuickBooks Online and specializes in providing QBO support.