Welcome back to Deal Camp! Today we're talking about financial statements and in particular the Profit and Loss (P&L) statement, also known as the income statement. Understanding the P&L statement is key to making more money and keeping more money for yourself. Let's get into it!
What is a P&L Statement?
A P&L statement is one of three core financial statements used in accounting. It is a summary of a company's revenues and expenses over a given period of time. It is used to calculate the company's net income or net loss.
To illustrate how a P&L statement works, let's imagine a company that sells lemonade. They sell 20 cups of lemonade at $5 each, and spend $2 on sugar, water, and cups for each cup of lemonade. They also rent a table and a corner in their neighborhood for $35. Here's how it looks on a P&L statement:
- Revenue: 20 cups x $5 = $100
- Cost of Goods: 20 cups x $2 = $40
- Gross Profit: $100 - $40 = $60
- Overhead: $35
- Net Income: $60 - $35 = $25
If the company started with zero dollars in their bank account, at the end of the month their bank account would go from zero to $25.
Understanding the P&L Statement
The P&L statement is like a series of flows and funnels. You have streams of income and funnels that the money flows through, preventing money from flowing onto the balance sheet and into your operating account.
The P&L statement begins with leads that have converted into sales. This is also called gross income. It then immediately flows into the first funnel, called cost of goods. This includes the cost of the job materials or the widget materials, any commissions that you might pay, freight, etc.
What's left over after the cost of goods is called gross profit. This contributes to paying fixed costs. The goal is to have more contribution margin than overhead, as this creates a lot of money that can go into your cash account.
The next funnel is called overhead or fixed costs. This includes salaries, utilities, taxes, etc. Once you get through this, you're at what we call net income or the bottom line.
The same way that you tweak a sales funnel to increase the conversion rate and reduce the bounce rate off your website, you can tweak each step of the P&L statement to maximize net income. This may involve spending more money up front, which may reduce the money down the line and contribute to more money at the bottom.
Understanding the P&L statement is key to making more money and keeping more money for yourself. It is a series of flows and funnels, with streams of income and funnels that the money flows through. It begins with leads that have converted into sales, and then flows into the cost of goods, gross profit, overhead, and finally net income. By tweaking each step of the P&L statement, you can maximize net income and create value.