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Know Your Numbers: Profit and Loss Statements Explained

Know Your Numbers: Profit and Loss Statements Explained

By Marco Carbajo, Guest Blogger
Published: March 10, 2015 Updated: March 12, 2015

On CNBC’s Shark Tank, one of the most important lessons that unprepared entrepreneurs learn after ruthlessly being chewed up is the importance of knowing their numbers. Ari Hoffman, Chief Operating Officer for Gobie H20 (episode 426) says, “It cannot be said enough, know your numbers. Even though the show is intended for entertainment, the Sharks are 100% real business investors who are experts at picking companies apart and seeing where the true value lies.”

The fact is that numbers tell the real story of a business. If you want to be successful at managing a business then you need to be able to understand certain numbers such as your profit and loss statement, cash flow statement and your balance sheet. These statements determine the health of your business.

The profit and loss statement (P&L), also known as the net income statement, shows if your company is making money, breaking even or operating at a loss. Obviously you want your business making a profit, but if it isn’t showing a profit, there are some key factors influencing that number that you need to pay attention to.

Let’s take a close look at some important numbers and what it takes to improve the bottom line. When you learn how to make a profit and loss statement and use it to your advantage, the faster you can turn around a business and generate profits.

Some of the key areas to look at are the following:

Pricing – How you price your products/services has a direct impact on your bottom line. First, you need to know the exact unit cost (labor, materials, etc.) for every product your company sells, which is known as cost of goods sold (COGS). The price of your product must be higher than your unit cost if your product is to be profitable. Typically, you would sell your product for the unit cost plus 45 percent.

If you find that your pricing doesn’t cover the cost to make your product or is way below the 45 percent target, there are some changes you can make. First, consider raising your prices, but only do so if you can still remain competitive and your customers are willing to pay for it. If you find that your product is underpriced compared to your competitors, then raising your price is definitely something worth considering.

Second, lower your unit costs by reducing costs of labor and/or materials. Finally, if you can’t sell your product at a high enough price to be profitable, then you may need to consider dropping that product from your lineup. Don’t get caught up in losing money and trying to make up for your losses in volume.

Every product or service you offer should deliver at least a 45 percent premium on top of what it costs to make it or service it.

Gross Margin – If you take the amount of product sales that you generate (net revenue) minus the cost of goods sold (COGS) you are left with what is known as gross margin, also known as gross profit. Remember, your company runs on gross margin ­­– not net revenue!

So if your gross margin is less than 30 percent of net revenue, then your company may run into trouble.

The gross margin is what is used to pay all the operating expenses and variable expenses of the company. Typically, the expenses include – but are not limited to – rent, payroll, insurance, office expenses, advertising, taxes, etc. So how can you ensure your business will generate enough of a gross margin to pay for all the operating costs and fixed and variable expenses of the company? Don’t sell products/services for less than costs of goods sold (COGS) plus 45 percent – that’s how.

Other factors that impact your bottom line are your company’s expenses. Work at keeping your fixed expenses as low as possible. Some variable expenses are much easier to control and scale back if needed during slow months, such as advertising and marketing expenses.

The profit and loss statement reveals whether your company is generating profits, breaking even or losing money. Focus on delivering positive numbers on a consistent basis; it is the key to your long-term success. Need help? This worksheet can help you calculate your P&L statement.

About the Author:

Marco Carbajo
Marco Carbajo

Guest Blogger

Marco Carbajo is a business credit expert, author, speaker, and founder of the Business Credit Insiders Circle. He is a business credit blogger for Dun and Bradstreet Credibility Corp, the SBA.gov Community, About.com and All Business.com. His articles and blog; Business Credit Blogger.com, have been featured in 'Fox Small Business','American Express Small Business', 'Business Week', 'The Washington Post', 'The New York Times', 'The San Francisco Tribune',‘Alltop’, and ‘Entrepreneur Connect’.