Understanding How To Read Your Profit & Loss Statement Can Give Your Company A Competitive Edge

Distributing your own company financial data  is a sensitive subject for many business owners.  If you want to obtain a critical bond line or bonding capacity  it’s an absolute necessity.  The two basic choices for a firm are to use their accounting software such as Quickbooks or hire a CPA to put together a formal financial statement.  Many will go unread unfortunately.  After all, it is everyone’s goal to increase sales more than last year and if you did that, you’re doing well, right?  Not necessarily – Gross sales alone cannot tell you everything you need to know and often could mean your actually losing more money than ever. Consider that in their first few years of business Amazon.com had billions in sales but were drowning in red ink, losing more money each quarter.   Understanding and learning to use the basic information found in a Profit & Loss Statement (also known as an Income Statement) can give you that extra edge not only in your industry but with NY Surety  or NY Bonding Companies as well.

What is a Profit & Loss Statement?

In order to understand what a P&L Statement is we will compare it to the more common Balance Sheet.

The Balance sheet is a report on your company’s worth & debts at a specific point in time.  The P&L Statement is a report on your firm’s cash flow over a specific length of time – it could be a week, quarter, year or any other period that makes sense to you.  The P&L statement will not only help you identify key expenditures that require attention but time periods as well; thereby helping you predict future performance.

Key Components of the Profit & Loss Statement

Now that we know what a P&L Statement can do for you, the next step is identifying the major interest points so we can then use the data in a constructive method.

  • Revenue or Sales – is what you receive for your services.  This is the first entry in the income statement. All expenses are deducted from this amount.  The remainder is profit.
  • Cost of Sales – This is generally your cost of goods, direct labor (including subcontractors).  This is the first item deducted from your Sales.
  • Gross Margin – Is the balance deducting the Cost of Sales from Net Sales.
  • Selling Expenses – Direct & Indirect costs you sustain from making the sales – advertising, salespeople salaries/commissions.
  • General & Administrative Expenses (G&A) – all other costs not tied directly to the services you provide – administrative staff payroll, rent, communications and other overhead expenses.
  • Profit from Operations – deducting Selling and G&A expenses from Gross Margin.
  • Net Profit Before Taxes – Considers any other expenses or income that don’t apply to any of the above categories.  If there are no other items, then Net Profit Before Taxes = Profit from Operations.
  • Net Profit After Income Tax – This is the balance after deducting income taxes from your Net Profit Before Taxes – this is your “Bottom Line”

Turning the Data into More Useful and Relevant Terms

We know what the P&L is, we know the key data points – How do we make it work for us?  Below are five tools for analyzing your firm’s profits and performance:

 

  1. Gross Profit Margin Ratio – Calculate your Gross Profit Margin by subtracting the Cost of Services from the Net Sales.  Divide this figure by the Net Sales.

What does it do for you? By comparing your GPM Ratio to that of a previous operating period you can see how efficiently your firm is operating.  If your ratio is lower today than previously it indicates your costs (as a percentage of sales) have risen thus suggesting a less efficient operation.  If your ratio is now higher than a previous period, you are now operating on a more efficient level.   The ratios can be taken for any period of choice – so while you may not see much fluctuation on a year to year basis you may discover seasonal changes of which you may not have been previously aware.

  1. Operating Profit Margin Ratio – Subtract your Cost of Sales, Selling Expenses AND G&M Expenses from your Net Sales then divide this sum by your Net Sales.

What does it do for you? Operating Profit Margin is typically your key source of cash flow.  By comparing your ratio to previous periods you can obtain a good idea of your firm’s health.  An increasing ratio shows an increase in cash flow as a percentage of sales.  *Note* If your Gross Profit Margin Ratio is increasing but your Operating Profit Margin Ratio is not this means your Selling or General Administrative Expenses are increasing faster than your sales.

  1. Net Profit Margin Ratio – Deduct all expenses including income tax then divide this sub by your total revenue.

What does it do for you? By comparing periods (yearly, quarterly etc) you can see if your tax situation has changed.  Additionally since “other income” is included in the net profit, variations may indicate non-recurrent expenditures.

  1. Common-Size Ratios – Every company, even  Home Depot, has a P&L Statement –showing the same basic information.

What do they do for you? By viewing at your P&L as a series of ratios rather than dollars you can easily compare your operations not only to your own prior periods but to other companies as well – even those several times larger (or smaller) than your own.  Every company has a P&L Statement – all showing the same basic information.  By comparing your firm to others, especially those in the same industry segment, you will be able to more readily identify the areas of your operations that are doing well  But more importantly you may be able to zero in on the areas that are not operating as profitably as they could.

  1. Break Even Analysis – Take your Fixed Costs (those that do not fluctuate on sales volume – such as rent, admin salaries, overhead etc..) and your Variable Expenses (those that fluctuate on volume of work (materials, field labor etc..) and subtract them both from your Total Sales.

What does it do for you? If after deducting your Fixed & Variable Costs from your Total Sales your answer is $0 – this means you are not losing money but you’re not making any profit either.  If your number is less than $0 then your firm is losing money and you should begin a detailed examination of where changes can be made to bring you back into the black.  Even if you are turning a profit, keeping an eye on your Break Even Analysis can show you your “cushion” and can alert you to make adjustments before you’re in the red.

A Surety underwriter not only looks to see if a construction firm knows how to do a job but also how profitably the firm is run as well.  By becoming familiar with your Profit & Loss Statement as well as the tools outlined above you not only take control of your business practices but position yourself as a more attractive prospect in the NY Surety marketplace.

Contact a Risk Advisor by calling (877) 874-2155 or by clicking Metropolitan Risk Advisory .  Let us position your company to compete stronger in your native marketplace.

 

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Explore posts in the same categories: Uncategorized, Various Surety Issues

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