Understanding Profit and Loss

Profits and losses are two of the most essential components to understand when it comes to business accounting. Most of the calculations, tracking, and analysis that is carried out when managing accounts is either directly related to profits and losses, or at least close. In fact, a large proportion of the daily tasks undertaken by a Certified Public Accountant (CPA) is dedicated to tracking profits and losses as they apply to the clients’ businesses.

One of the most common accounting practices relating to this is the generation of a Profit and Loss Statement. These are commonly required for taxation purposes, but they have far wider-reaching benefits when it comes to successfully running a business. As well as providing a business with a snapshot of its overall health, they enable management to far more accurately set, track, and monitor both their KPIs (Key Performance Indicators) and their OKR's (Objectives and Key Results) to vastly increase their chance of success.

So, what exactly are profits and losses, and what is essential to understand about them? 

It’s clear that they relate to both money made and money lost, but what factors come together to arrive at those specific numbers? Let’s take a closer look.

What Is A Profit and Loss Statement?

Essentially, a profit and loss statement is a financial document that summarizes a company's profits and losses over a specific period of time. The profits and losses are calculated based on the balance of costs, revenues, expenses, overhead, and more.

These statements are commonly used to calculate certain aspects of taxes for a business and may be required for business tax filing in some cases.

How These Statements Differ From Cash Flow Statements

While the document may seem like simply a list of everything the business has bought and sold, a profit and loss statement is actually not the same thing as a cash flow statement.

Instead of simply relying on incoming and outgoing funds, these statements take into account many aspects of accounting that CPAs are familiar with, including:

• Revenue recognition - all revenue is recorded when specific conditions are met, not when cash is collected
• Matching - expenses are put into the same period as the revenue they generate to align with the cause-and-effect aspect of the business
• Accruals - transactions are recorded when they occur, not when payment is made or received.

Profits vs. Losses

Now that you know more about the idea of a profit and loss statement, it’s time to understand more about what type of data is accounted for while creating the statement. 

Businesses are complex, and there are usually many factors to consider when arriving at an accurate accounting picture of the overall operation. At the base level, however, the following items can be considered as the foundations of profits and losses:

• Sales income - income received for the sale of products or services
• Cost of sales - what it costs the company to buy or manufacture the items sold
• Marketing and promotional costs - costs incurred in the promotion and advertising of the business
• Delivery costs - how much it costs to distribute products, minus any discounts for bulk shipping
• Overheads - all indirect operating costs such as salaries, contractor payments, cleaning costs, office rent, utility charges, and more

At the base level, profits can be projected by simply adding up a company’s gross profit and then subtracting out any overhead costs. This number, however, is not an accurate representation of exactly what the business is forecast to make. You can also calculate your profit here.

Consequently, learning how to create accurate profit and loss statements, as well as revenue forecasts can help you to build a stronger business, based on a solid foundation of accurate accounting and figure analysis.

Benefits Of Forecasting Profits and Losses

Though Profit and Loss statements are most often generated for tax purposes or quarterly reports, these statements can also be beneficial for improving the overall operations of the business as well. The document gives you a more comprehensive understanding of how your business is making a profit, and may, therefore, also highlight areas in which you could make changes to maximize opportunities for additional profits.

There are many practical reasons for making a profit and loss forecast statement. These include:

Gaining Clear Information

This statement will help you to clearly see where you need more funding, where there may be excess funding, and where you might be able to increase revenue. Without accurate information to hand, determining any necessary changes to the business can be difficult. Free Profit and Loss statement templates can help you to do just that.

Improved Client Management

Another aspect of the profit and loss statement that businesses often find beneficial is tracking the late payers among your clients. Once identified, you can find ways to proactively ensure they pay on time in the future. Better cash flow is essential to growth, and on-time payments are necessary for financial forecasting to work.

A Focus On Growth

In many ways, profit and loss forecasts help you see your business’s short-term health with an eye towards the medium-term. This information allows you to see trends, make meaningful changes, and plan for your long-term growth.

Goal Setting

Whether you are trying to plan to add new products to your range, make personnel increases, or act upon some other significant change in operations, forecast information can assist you greatly in making those decisions.

It also allows you to set goals based on current and forecasted figures. As part of the bigger picture in terms of business growth, you can map out certain goals and milestones you need to reach along the way, and plan how to roll them out in keeping with the data insights you have. 

Key Performance Indicators

You can also use Key Performance Indicators (KPIs) to monitor, track and manage the performance of both your business in general and in relation to your specific goals. Setting certain numerical targets is a great way to keep up-to-date with how your business’s financial success is tracking. You can use software to track your business’s daily activities in real-time with Hirebook’s KPI Software, resulting in increased employee engagement and key performance metrics. 

Reach For The The Big Picture

Are you ready to look towards the big picture and your long-term growth? You can use a profit and loss forecast template to efficiently and accurately work towards your longer-term goals. With accurate and comprehensive information to analyze, you will be empowered to make more informed business decisions that stand a much better chance of proving successful.