KLP Consulting, LLC - December Expert Article

Balance Sheet, Equity Statement, Profit and Loss Statement (P&L) aka Income Statement, and Statement of Cash Flows.  All are FANTASTIC reports, but with which one should a business owner become best friends?  To answer that question, we must understand what each is telling us.

The Balance Sheet is a picture at a single point in time and answers, ‘What do I own, what do I owe, and what is remaining?’   An Equity Statement is showing how much of the business is yours after debt and answers, ‘How has my ownership value changed?’  The P&L summarizes revenues, expenses, and net profit/loss, and answers the question, ‘Am I running profitably?’  Lastly, the Statement of Cash Flows shows how cash is coming in and going out and answering, ‘Where is the money actually going?’

So which should be a business owner’s best friend?  Hands down, the P&L!

While it is known that P&L’s show actual revenue, expenses, and net profit/loss, what may not be known is what those numbers are actually telling us.  Looking at them once, you can get valuable information, but when viewing them daily, weekly, or monthly, the information becomes invaluable and provides you with the ability to spot trends quickly:  Revenue, Expenses, and Profit Margins – are they holding steady, growing, or slipping?  No matter what the answer is, the P&L also then allows you to drill down to the cause and determine if action is needed.

To illustrate, let us say we have been promoting a “10% sale” on sneakers for the month of November.  Looking at our P&L daily, a pattern of increasing revenue and expenses has been observed, but our net profit margin is decreasing.  What is happening?

One likely scenario:

Revenue is increasing because the sneakers are selling out as quickly as we can bring them in, and other merchandise is also selling at an increased pace.  Expenses are increasing because of the additional costs of the marketing campaign, increased inventory, shipping costs, and personnel.  This makes sense because of the seasonal spike.  But shouldn’t our net profit margin also be increasing given the increase in revenue? 

Not necessarily.  If proper cost control and margin pricing practices are not adhered to, that 10% discount, in reality, is probably eating a larger portion of profit than was thought.  Therefore, with each pair of sneakers sold, more profit is being lost and the additional expenses incurred are having a greater impact on the bottom line, i.e. decreasing net profit margin.

Short-term, the action to take might be to pull back on the marketing or start emphasizing higher margin items to offset the loss.  Long-term, review your pricing strategy.  Verify product and service pricing align with your desired margins, including future promotional considerations.

Being the proverbial Chief Officer of Everything is challenging enough.  Why not simplify the ‘how’s my business doing’ question and get to know your P&L?  Knowing your P&L is to know your performance.  Mastering it is to master your profitability.