Look, nobody goes into business to stare at financial spreadsheets. Beyond money and the ways we keep track of how it’s coming in and going out, entrepreneurship is about carving out a lane for yourself, your team, and your beliefs.
Yet if you don’t pay close attention to those spreadsheets, your entrepreneurial dream could crumble and you’d have little understanding of why. Sustainable entrepreneurship takes discipline. As the judges on Shark Tank say, you have to know your numbers.
The Profit and Loss Statement
To borrow from another one of my sources of entrepreneurial inspiration, Seth Godin routinely urges small business owners to—at a minimum—take a monthly tally of the numbers they care about most. The details may vary, but he says each entrepreneur should know the following:
- How much cash she’s making in a month.
- How much cash she’s spending in a month.
- How much money is in her bank account or cash reserves.
- At the current earning and spending rates, how many months before she’s out of cash.
The Profit and Loss Statement (P&L) is the perfect document to help an entrepreneur stay on top of these important high-level questions and more. The format of your P&L will differ depending on your industry and business structure. This article is designed to give you an overview of the P&L’s elements and why they’re important to know.
Top-line revenue is where most people focus. High revenue numbers is what makes it in the headlines! If you think of the P&L like a funnel, top-line revenue is what you start with.
In our business, we separate revenue on our P&L by revenue stream. We know the raw numbers for each stream and what percentage each contributes to our total revenue numbers. If you have one stream, consider breaking revenue down by customer or specific product. You might have too many products or customers to do that breakdown on the P&L itself. Bottom line, you should have that breakdown recorded somewhere.
Getting beyond the total revenue figure is critical. Maybe you’re reliant on a small group of customers or products to keep you going. What happens if circumstances change and you can’t rely on that group anymore? Know where you stand. Diversify. De-risk your business.
Returns, Refunds, and Discounts
You might have some or all of the above. If you do, you have to keep track of their financial value. You sold $100 worth of product, but you gave $20 off? Account for that $20 on the P&L. You had to give a refund? That refund counts against your top-line revenue.
Cost of Goods Sold (COGS)
It takes time and money to fulfill orders or provide a service. The P&L has a special place for these expenses: COGS. Here you might include salaries or labor expenses if you’re paying yourself and others. If you ship a product, shipping costs would fall in this category. If you use a payment processor like PayPal or Stripe, their dreaded transaction fees could be recorded here as well.
Let’s say you won a pitch and thus have some extra cash. For the first time ever you decide to spend $300 boosting your company’s Instagram posts. Unfortunately, the boosting doesn’t bring you new business (let this be a warning: never boost posts). As a result, you decide spending money on advertising is a bad idea and use your pitch competition winnings to try a new strategy the next month.
The $300 you spent on advertising is a variable expense—you might spend money on advertising again, you might not. That’s just one example of a variable expense and I’m sure you’re thinking of more now.
In addition to Google Sheets, I use Quickbooks to keep track of my company’s financial activity. On the ninth day of every month, Quickbooks charges my account for using their platform.
Quickbooks is a fixed expense. As long as I want to keep using their tools, I should expect a debit from our account on the ninth. Fixed expenses are pretty self explanatory. What fixed expenses do you have? In many ways, we use our fixed expenses to determine how much we can afford to take on in variable expenses.
Revenue minus discounts, etc minus COGs minus variable expenses minus fixed expenses equals income. As you can see, in getting from revenue at the top of the funnel to income at the bottom, there are many things to account for. There are several costs that can strip away revenue and leave you with little or no income after all of your work is done.
If you haven’t already, take the time to create a P&L statement for your last 12 months in business. Where’s most of your money coming from? Where’s it going? Did you make a profit or take a loss? No matter the answer, having consulted your P&L, you’ll be in a better position to make the next 12 months more fruitful.