Running a successful business involves a lot more than just passion for what you do, and a real pitfall for many business owners is a lack of understanding about key things like Profit and Loss statements, also called income statements.
Balancing the books and translating monthly financial reports are necessary parts of achieving success. It’s not an exciting part of running a company, but it’s critical in order to have real control of your business finances.
However, for fresh startups who have never had to deal with bookkeeping and accounting before, the associated admin can become an intimidating, jargon filled burden.
Accounting software like KashFlow is already empowering small business owners to take control and have better understanding of their accounts, including having access to easy to understand reports like Profit and Loss. We also have great accountant partners to help make things even easier for business owners.
Here’s a simple guide to understanding income statements from KashFlow partners Flow Online Accounting:
Sales – Expenditure = Profit
An income statement or a profit and loss statement very simply is a report that details what your company is worth (profit) based on a simple formula: sales minus expenditure. Flow Online Accounting says this formula is the backbone of income statements and only becomes difficult when different terms are used for sales and costs (such as revenue and expenses). No matter what, the formula remains the same: The money you make minus the money you spend equals your profit.
Breakdown of Sales and Costs
Sales and costs or revenue and expenses (or whatever terms are used to talk about your money in and out) can offer up some complications when you need to breakdown your sales into different sources. These ‘sub-sales’ will all be added together in one line called ‘total sales’. For example, sales from a cake shop could be split as so:
- Customers eating in
- Customers eating out
- Catering customers
- Special occasion customers
Flow Online says the process of separating and categorising sales like this is important, and not just for accountancy reasons. They say the analytical benefits of this are important too, because it gives business owners the ability to identify where their business is succeeding and/or failing in terms of sales.
Costs can also be broken down into subsets. For example:
- Cooking costs (ingredients, etc)
- Utilities (gas, electric, etc)
- Overheads (rent, business rates, etc)
- Staff (wages, bonuses, etc)
“There are countless ways in which you can breakdown your costs, but essentially they all equate to one ‘total cost’ that will be subtracted from your total sales line,” says Flow.
COGS, COS and SG&A
Don’t be put off by the abbreviations – these are just a useful way of subdividing your costs based on how those costs are associated with the delivery of your product and/or services.
So for example, the cost of your employees, your office or workplace premises and your materials are all regarded as COGS (which stands for ‘cost of goods sold’) because they are linked to the production of your goods. COS stands for ‘cost of service’ and refers to service related costs such as a maintenance services, fuel costs and service supplies. SG&A stands for ‘selling, general and administrative costs’. These costs are not directly associated with the production of your goods or the sale of your services and can include:
- Marketing costs
- Accountancy and legal costs
- Loan repayments
- Selling and advertising costs
The gross profit of your company is determined by minusing COGS or COS from your sales. This is how much money your business has earned in total, but includes the costs your company needs to pay to cover monthly direct debits and other costs associated with keeping the business running (such as SG&A).
Flow Online says:
“Once you subtract these costs (SG&A) away from the gross profit you are left with ‘net profit’ – which is all yours to do whatever you like with! So revenue minus COGS/COS equals gross profit and gross profit minus SG&A equals net profit. Easy as that!”
Net profit is your actual profit, money that you have earned and is unaccounted for; you can use this for anything you please, whether it is investment, bonuses or business development.
This content has been reproduced with permission from Flow Online Accounting, a leading online accounting service provider and a certified KashFlow partner. Click here to find out more about Flow and how they can help your business.