Each time your accounting team delivers you a profit and loss statement (P&L statement), they’re handing you key insights about your business’ profitability. A P&L statement, also known as an income statement, measures your business’ financial performance over a specified booking period — generally one month, one quarter, or one year.
While many business owners and managers feel overwhelmed at the wealth of data on the P&L statement, interpreting this data is essential to making informed business decisions. The good news is, you don’t need to learn how to calculate financial data — that’s what your professional accounting team is for — but you should understand how to read your P&L statement, and use the information to guide your business decisions.
You’ll see a lot of accounting-specific terms in this statement, but once you understand what they are (and how they relate to your business), the document isn’t too difficult to read.
We’ve broken down each section of the P&L statement below, to help you interpret what the numbers mean for your business.
Revenue is often referred to as the “top line,” because it’s the very first line you’ll see on your profit and loss statement. Revenue constitutes the sum of all sales, and acts as the base of the entire spreadsheet.
The Cost of Goods Sold (COGS) represents the costs directly related to making the goods or services your business sells. These costs range from labor needed for production to the cost of raw materials. As a business owner and leader it is important to define and track your COGS and to have enough detail in the COGS to understand the key components of your goods or services.
Once you know revenue and COGS, you can calculate your company’s gross profit, using this equation: Total Revenue – Cost of Goods Sold (COGS) = Gross Profit. This is also referred as your operating margin or gross margin. It is a key metric to benchmark against your industry.
Your gross profit is then used to pay the remainder of the costs on your P&L statement.
Selling, General and Administrative Expenses (SG&A)
SG&A can also be referred to as OPEX (short for “operational expenditure”). SG&A includes all expenses to market, sell, and deliver a company’s products and services, as well as the costs incurred to manage the overall company. This includes all compensation for the business’ employees (with an exception for labor costs already accounted for in the COGS bracket). This category will also contain office-related expenses, travel and entertainment expenses, non-COGS related consultants, bad debt (such as unpaid invoices), and other administrative expenses.
Earnings Before Interest and Tax (EBIT)
EBIT reflects the company’s productive efficiency, before taking into consideration the tax burden or how the company is financed. EBIT, also called operating income, is calculated with the following formula: Gross Profit – Total OPEX = EBIT.
Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA)
This calculation simply takes the EBIT, and factors out depreciation and amortization, to get a more clear understanding of current performance. EBITDA is used by investors as a proxy for cash flow, and for the amount of profit that can be made from a business’ current assets and operations.
At the bottom of your P&L statement, you’ll see Net Earnings — aptly referred to as your “bottom line.” Net Earnings may also be called Net Income, and shows the profit of your business. This grand total represents the actual “take-home pay in your company’s pocket,” once all sources of revenue, expenses, interest, and tax are taken into account. This amount is divided among shareholders or added back into the company as retained earnings.
Acting on the Numbers
Think of your accounting team as your own personal financial translator; using their skills and expertise to take your company’s raw financial data, and present it in a format that’s easier to understand and act on. While you can leave the data analysis to those who do it best, the task of reading and interpreting the P&L statement isn’t just a job for your accounting department; it’s essential to the decisions you make as a leader.
Your profit and loss statement is one of the greatest tools at your disposal, whether you’re a veteran business owner or a startup entrepreneur. Because each statement focuses on one specified booking period, you can compare multiple P&L statements from previous periods, to see whether your business’ profitability is increasing or decreasing over time. With this statement consistently updated and on hand, you have a clear breakdown of your business’ costs and revenue — allowing you to make informed decisions about staffing, spending, and production for future success.