Every month you or your accountant creates a profit and loss statement (P & L) for your business and reviews any pertinent information. If you are like most business owners, you look at the net income and maybe a few other numbers and file it away. But if that is all you do, you are missing many of the important stories your P & L tells.
The language and format of a profit and loss statement may be unfamiliar to you if you are not an accounting professional. Once you understand how to interpret a P & L, it reads like a storybook that tells the tale of your business’ financial progress over the past time period, be it a month or a year. When you dive into some of those stories, you learn a lot about your business that you may not have discovered anywhere else. These stories are important because they can help you identify mistakes and fraud, profitability of jobs and opportunities for growth, such as new, more profitable product mixes.
Identifying Mistakes and Fraud
The buzz around the office is about the big client the sales team just closed and how, that, combined with the decline in prices of raw materials, is going to make a great year. Sitting down to review the P & L, you anticipate seeing a nice big number next to net income, but it is much lower than you expected. The P & L is telling you the story of your business, but it is not matching up with your expectations. How could that be? The P & L offers clues to help you discover the problem. Looking at the P & L, you may see that it shows that raw material costs are going up, not down, which does not match with what you had been told by your operating crew. It may be due to a bookkeeping entry error or perhaps while some raw materials prices are decreasing, others are rising. This could also be a sign that some kind of fraud or theft is occurring, requiring you to review your internal controls.
The P & L may offer another explanation for lower than expected net income numbers: issues with job profitability. Even with a great year in the sales department and reduced prices on your raw materials, the jobs or products may simply not be profitable. The P & L can help you identify why. For example, did you hire more staff to manage the additional sales? Maybe those salaries are higher than what you can handle to still be profitable. Maybe additional staff was not yet hired and the quality of the work of the current staff is suffering, creating more warranty claims and returns, which you will also discover by reviewing and investigating these variances on your P & L.
Opportunities for Growth
Your P & L does not just identify potential problems; it also shines a spotlight on opportunities. The ratios on the P & L can be compared year-to-year, showing you which jobs or products are becoming more profitable over time and which are declining. This information can help you identify product mixes or job types that could increase the company’s financial performance. You may decide that the sales team for the area that is improving can share their techniques with the other departments.
Next time you sit down with your accountant to review your P & L, ask about the story it tells. If the story does not flow with the tales you have heard from your team, explore the reasons why. You may not find yourself sitting around the campfire reading your P & L to your grandchildren or anxiously waiting for it to come out as a movie, but it is still a story you do not want to miss.