Brian Clarke of H&J CPAs explores profit and loss and explains why it is important to regularly review it.
Each month, company owners are presented with a profit and loss that has been generated by their accounting software. Many times, this report is simply filed away without much thought, but owners should pay close attention to it.
There are several things to learn from the profit and loss report, but the first thing most of us are drawn to is the bottom line. Was the company profitable during the year, and how does that profit compare to the budget that was established for the year, if a budget exists? Regardless of whether you exceeded or fell short of what was expected, you should look more closely at certain areas to identify if there are signals that you should pay attention to.
First and foremost, if you fell short of expectations, you want to know specifically where things changed course. You’ll want to compare the budgeted profit and loss to the actual results for the period. Where are the differences, and why did these differences take place?
Taking these in the order that they appear on the profit and loss, did revenue fall short of expectations and, if so, why did this happen, was there a reduction of customers during the year and, if so, why, what is being done to get customers back or replace them, and was the gross profit percentage consistent with what was budgeted and, if not, why not? In general, absent significant changes in the company markup percentage, the gross profit as a percentage of revenue should approximately match what was budgeted despite the actual dollar amounts fluctuating as the revenue volume does the same.
If the costs are not as anticipated, further analysis into the reasons for the differences is needed as well as any adjustments moving forward.
Does this mean there needs to be an increase to the prices of goods or services, or is the difference due to not paying enough attention to the costs that are being incurred during the year, which also is an issue that needs to be addressed? Are total operating expenses consistent with the budget? If not, which line items differ? This is where you need to investigate why the differences exist and how they affect operations moving forward.
In general, most operating expenses should not differ as a result of a change in revenue. Having a routine of regularly reviewing your profit and lost and making any necessary adjustments as you go should allow you to avoid unwanted surprises at year end when it is too late to make most adjustments.