A key element of running a business is setting up a profit and loss (P&L) Statement. It is a financial statement that lists the receipts, outlays, and costs for a given time period. The P&L account is a critical tool used to evaluate the financial health of a company because it displays whether a company made a profit or a loss during a specific period of measurement. It is also an excellent tool that allows a company to accurately forecast its revenue and expenses.
Creating a P & L
To create a P&L account, follow these steps:
1. Chose the time period for the P&L:
Choose the time frame for which you want to establish the P&L statement. This may be a week, a quarter, a full year, or multiple years as in a 5-year plan. It's important to select a time frame that applies to your company or the expectations of a bank, buyer, or investor.
2. Collect and forecast your revenue:
This step is used to compile your revenue data. This covers all of the income (revenue)r your company made during that time. Sales, services, and investments are only a few possible sources of income. Keep thorough records of all your sources of income. As your P & L extends into the future it becomes a forecast. That means you will need to accurately predict or forecast your income (Revenue).
3. Determine your cost of goods sold (COGS):
COGS is the cost that you paid to produce or buy the goods or services that brought in the revenue. This comprises the price of supplies, labor, license fees, royalties, credit card fees, administrative expenses, or any other fee needed for the actual effort to transact any given deal.
Determine the COGS for the specified time period. You will need to forecast Cogs into the future as you do the revenue. A simple way to do this is to forecast COGS as a percentage of your revenue.
4. Calculate your gross profit:
Revenue less cost of items sold equals gross profit.
Revenue - COGS = Gross Profit
(Revenue-COGS)/Revenue = GP Margin
This displays the revenue generated by the sale of goods or services during the specified time by your company. Gross profit is an important metric for determining how profitable your company is. It can also be used to manage prices and how salespeople discount any given transaction.
5. Calculate Operation Expenses:
The costs incurred to run your company, such as rent, utilities, salaries, and marketing charges, are known as operating expenses. They are expenses that will occur regardless of how much product you sell. In other words, operating expense is the sum of all the expenses that are not (COGS)
The operating profit is calculated by deducting these costs from the gross profit.
6. Find your net profit:
The amount of money left over after all costs are deducted from revenue is your net profit. This covers both running costs and any additional costs incurred throughout the time frame. Your company is profitable if your net profit is positive; on the other hand, if it is negative, your company is losing money.
Creating a Forecast
As stated earlier, you can (and should) use your P&L statement to forecast sales and cash flow once you've established it.
To estimate future sales, also known as a forecast:
1. Predict your sales:
Predicting your sales for the forthcoming time period is the first step in developing a revenue projection. This may be based on previous data, market trends, or other elements that could have an impact on your company. If you have a sales team, you can require them to submit this forecast.
When constructing a revenue estimate, it's crucial to take into account many situations, including the best-case, worst-case, and most likely scenarios. You may make better decisions and plan for many scenarios because of this.
2. Establish your pricing strategy:
It's critical to choose the appropriate price strategy for your goods and services because it can have an impact on your revenue. This may depend on variables including market competitiveness, manufacturing costs, and consumer desire.
3. Evaluate your market:
Doing so will enable you to spot any growth or development prospects. This can entail studying your target market, figuring out what they need, and creating marketing plans to reach them.
Making a cash flow projection
This is typically something that a CPA or an accountant can do for you. However, you can do it yourself
1. Calculate your cash inflows.
Cash inflows are the funds that your company receives over a given time period. Cash sales, receivables, and other income are included in this. Based on your revenue projection and any additional sources of income, you can estimate your cash inflows.
Again, this is why a good P & L is essential. If you have one with a forecast, you can estimate all incoming cash.
One key element of this is understanding Days Sales Outstanding (DSO). DSO is a working capital ratio used to calculate how long it typically takes a business to collect its accounts receivable. The faster the company obtains money from its clients and can put its cash to use, the shorter the DSO.
If you collect payment upfront (Credit card ACH, etc.) then you have a 0-day DSO. If you give terms then it might be a 30-45 days DSO, etc.
Finally, Monthly Recurring Revenue (MRR) can be an excellent way to manage positive cash flow. Monthly Recurring Revenue (MRR) is the predicted total revenue that your company generates from all of the active subscriptions in a given month. One-time fees are not included, only recurring fees from discounts, coupons, and add-ons.
2. Calculate your cash outflows:
The cash expenses that your company incurred within the same time period are known as cash outflows. This comprises payments for operational costs, loans, taxes, and other obligations. Based on your operating costs and any other expenses, project your cash outflows.
Remember to take into account that as your business grows so will your expenses.
3. Think about your cash reserves:
These are the funds that your company keeps on hand to pay for any unforeseen costs or deficits. While making a cash flow prediction, it's crucial to take your cash reserves into account since they may have an impact on your capacity to meet other financial commitments and pay payments.
Three to six months' worth of costs is a typical reserve aim. The maximum quantity of reserves should not exceed your total expense budget for two years. If This is the case, you are not letting your cash work for you in growing the company. At a minimum, cash reserves ought to be sufficient to pay for one full payroll with taxes.
4. Evaluate your cash flow:
You may spot possible problems with it and take preventative measures before cash becomes a problem. Tracking your cash inflows and outflows, putting together a cash flow statement, and figuring out any cash flow holes can all help with this.
You can improve your understanding of the financial health of your company and make smarter decisions by developing a P&L account, a revenue forecast, and a cash flow projection. To maintain your company's long-term prosperity, keep in mind to frequently update your financial statements and continuously analyze its financial performance.