When I meet with new clients, I find they all like to look at their Profit & Loss (P & L or Income Statement). After all, who doesn’t like to look at profit?! But I find many have misconceptions about what this report can/should do for them. This is usually due to a lack of knowledge when it comes to accounting, which I understand. But whether you are the business owner or the bookkeeper you should understand at least a little bit about accounting and your financial reports.
If you are the bookkeeper, you’re the one doing the data entry, so it’s important that you understand how the transactions you’re creating are affecting the books. And if you don’t, ask your accountant. Some mistakes can be huge. A couple examples I’ve either seen first-hand or heard about:
- Expensing loan payments
- Entering vendor invoices (i.e. your bills) as invoices
- Entering bank transfers as income to the business
- Assuming that if you use the online banking/bank feeds, you don’t have to reconcile your bank & credit card accounts.
Those mistakes can have a huge incorrect impact on the Profit & Loss report.
If you are the business owner, these are your numbers so you should understand what this report can and cannot tell you. Don’t be afraid to ask your accountant!! After all, your business is your area of expertise and accounting is theirs. So, especially in the beginning, I understand this can all seem like Greek!
I know some business owners are hoping this report will help them with their cash flow if they run this report on a cash basis (I had someone contact me one time wanting to know why this didn’t match their bank balance). That’s not the intent of this report. The focus is on profitability (not cash), so loan payments, sales tax remittance, payroll liabilities, are not to show on your P & L, yet they obviously have a big impact on cash flow. If you see them on this report, then find some help with getting your books corrected.
The purpose of your P & L is to show you Profitability and the factors that affect it. When you run your Profit and Loss, you’ll first see Income, then many of you will a middle section for Cost Of Goods Sold (COGS) and below you have expenses, with the net income or loss at the bottom. The Profit and Loss covers a period of time, which you choose, such as last month.
The types of expenses classified as Cost of Goods are typically those purchases you made in for a specific job, project, or product. Some examples are:
- a retailer who had to buy products (inventory) that they could put on a shelf for resale.
- a manufacturing company who has to purchase raw materials to make a product to sell.
- for a contractor it would be the materials purchased specifically for the job (like lumber, landscaping, appliances, etc.) and the labor involved for that job. (Note: if you are a contractor and you don’t have labor costs showing in your COGS, you’re not seeing the total costs associated with your jobs.)
Expenses are typically those associated with running your business whether or not you have jobs/projects, such as rent, your phone bill, internet access, utilities, and so on
While the bottom line doesn’t change, it’s more helpful to see the direct costs (COGS) separate from the overhead (expenses). For instance, many of you want a particular profit margin for a job.
When setup correctly, you can run a P & L for job, turn on percentages, and the % showing for Gross Profit Margin is your profit margin! And when you run the P & L for the company, you’ll see your profit margin across all your jobs. Simply click to customize the P & L report, then check % of Income on the Display tab.
When you have percentages turned on, then you’ll also see your Net Margin as a percent.
Both can be useful for planning purposes and giving you targets you need/want to achieve
Cash vs Accrual
One other aspect to look at when reviewing your financial reports is cash versus accrual basis. Most of my clients operate on a cash basis for tax purposes, but several operate on an accrual basis. If you’re on a cash basis, (in oversimplified terms), you earn the money when you get paid and you spend money when you write the check or pay by credit card. Most of us can understand that, since that’s typically how we treat our personal finances. Technically, cash-basis businesses don’t have an Accounts Payable or Accounts Receivable. But accrual says that you earn the income when you invoice whether or not the client ever pays you! And you spend the money on the date of the bill whether or not you ever pay the bill. Those on an accrual basis can write off bad debt. Those on cash basis cannot write off bad debt because they never originally claimed the income.
I generally recommend that clients look at their reports on an accrual basis because it typically evens out some of your income and expenses and is better for showing trends in your business. On a cash basis, sometimes cash comes in sporadically so you may find you pay several bills at once so you have understated expenses for some months and overstated expanses for other months. So cash basis doesn’t necessarily reflect the work that’s being done in business. Starting with 2018, QB made it easier to switch between cash & accrual – the option is right on your report screen!
So, take a closer look at your report and see if problems jump out at you or if you get some new “aha’s”! If you need help with this, you can contact our office or your accountant.