Financial statements including your balance sheet, income statement, and profit and loss statement give you insights you need to improve your company’s performance. They can even help you raise funds because lenders and investors usually want to check your business’s financial health.
The truth is that tracking profits and losses can quickly become a difficult task. However, doing so lets you make more informed decisions that can help your business avoid financial hardship and even business bankruptcy.
Today, we’ll focus on the profit and loss (P&L) statement and how to handle P&L management. But what is P&L management, and how do you go about managing profits and losses effectively?
What Is Profit and Loss (P&L) Management?
Profit and loss management is the process by which you manage the cash that flows into and out of your company. The process starts with the creation of a key financial document: your profit and loss statement.
This statement clearly outlines your startup’s income, cost of goods sold, gross profit, expenses, taxes, and the net profit or loss it has generated for the covered period. Once you have your P&L statement in hand, profit and loss management involves the following:
- Cost Management: Develop a detailed understanding of your business expenses, including operating costs and non-operating expenses. Consider opportunities to optimize your spending. For example, if you notice a cost overlap between departments, think about what you can do to only cover the expense once.
- Revenue Management: Revenue management involves forming a deep understanding of your revenue sources. When you have a better understanding of your revenue streams, you’re able to allocate more dollars to your highest conversion products and services.
- Asset Allocation: Finally, you’ll use the information you gathered to make informed asset allocation decisions. For example, your P&L reports will likely uncover seasonal differences, so you can adjust your inventory purchase orders based on what's actually needed.
The Strategic Role Of P&L Management In Startups
At a minimum, business owners should carry out the P&L management process on an annual basis. However, startups should look at this data far more often.
As you work through P&L management, you’ll be looking for ways to reduce your startup’s cost of revenue — the expenses involved in producing your product or service — leading to improved profit margins.
The P&L process lets you better understand your company’s revenue streams and which of those streams is most efficient. That helps you focus on dedicating your assets to processes and revenue streams with better ROI.
This focus can improve your startup's financial health and speed up your business growth. Read on to learn how.
Financial Performance Assessment
Profit and loss management requires performing a financial performance assessment. This is when you dive into your cash flow statement and profit and loss statement to determine how well your startup uses its assets to produce an operating profit.
If your startup is producing a profit that’s growing consistently, look into the asset allocation that’s leading to that growth and consider expanding it. If you’re not generating a profit, consider what costs you can cut and how you can better allocate your resources to high-performance areas of your business.
Decision-Making And Resource Allocation
In the early stages of your startup, you likely made most decisions according to your business plan. However, as your business begins to incur costs and generate revenue, you may need to tweak your plan here and there.
That’s an area where P&L management shines. The P&L process gives you a better understanding of where your business can afford to cut expenses and where it will benefit from additional spending.
So, as important resource allocation and other decisions arise, you’ll be well-equipped to make educated decisions that will have a positive impact on your company as a whole.
Over time, P&L management could completely shift your business model. After all, if you notice that what you thought were ancillary products and services are producing the largest ROIs for your startup, you may shift your business model to focus more on these than your current core products.
Performance Benchmarks And Goal Setting
Few startups generate an immediate profit. It can take years to get to that point. However, your profit and loss management process can help you set goals to work your way toward profit and then toward growth. Consider these areas when performing the P&L process:
- Cost of goods sold (COGS)
- Operating expenses
- Gross profit
- Gross margin
- Net income
- Net margin
- Annual revenue
Look into how your startup is doing in terms of these Key Performance Indicators (KPIs) in relation to industry benchmarks. Once you know where you stand, define monthly, quarterly, and annual goals to improve these figures and improve your startup’s overall financial health.
Key Elements Of Effective P&L Management
There are seven key elements of effective P&L management. Those include:
- Income, revenue, and sales: First, it’s important to keep track of all money that flows into your startup. This could be income from investments, sales, or any other means.
- Cost of goods sold (COGS): This measures the total cost of selling a product or service. You should keep close tabs on your COGS and do what you can to keep them as low as possible.
- Operating expenses: These are costs that aren’t included in your COGS. Consider ways to optimize these expenses as you manage your profits and losses.
- Gross profit and gross margin: Gross profit and margin relate to how good your company is at turning COGS into revenue without the noise of operating expenses. You should always work to increase these numbers.
- Net income and net margin: These relate to the money you keep in the bank after all’s said and done. Your goal is for these to be positive numbers that grow each reporting period.
P&L Management Made Easier With The Right Software
The simple fact is that, if you want your startup to grow to become an enterprise-level company, you’ll need to practice sound P&L management. That creates a new challenge. How do you keep track as a startup owner who already wears several hats?
That’s where software solutions come in.
Take advantage of quality bookkeeping and accounting software. In particular, look for state-of-the-art solutions that make it easier to keep accurate records and assess data as you capture it.
A quality solution can not only generate a profit & loss report, it can also help you visualize your cash flow and make effective optimization decisions.