Understanding Your Profit & Loss Statement | Hire A CFO Edmonton
Hi, thanks for joining us for another episode of ask the spiral CPA. Today we’re talking about understanding your profit and loss statement. I’m here with Laura. Laura, thanks for joining me here today. Lori, are you looking forward to your first personal tax season? Okay, so any particular projects you’re looking at and excited to work on or I’m looking forward to doing some rental property. I’m sure we’ll, we’ll have some clients and some rental properties or work on. So the, the, the quote today, understanding your profit and loss that we want to bring to you is by Warren Buffet. Accounting is the language of business. And of course, you know, we’re, we’re really committed that uh, you know, the statistic we always bring up is 50% of all Canadian small business fail. And you know, one of the three main reasons of why that happens, they run a cash. So understanding your profit and loss statement is important to prevent that. Um, and there’s the story is that, you know, we get business owners and they’re making important decisions based on these profit and loss statements that, that they’re either incorrect or they don’t really understand the profit and loss statement. So, Laura, what are you, what do you think are the questions that these business owners, they should be asking?
Why should you look at the balance sheet before the Yukon State? So this is, you know, we have a, a whole other video on this one as well. But you know, a lot of times there is obvious errors in the income statement that if you have a look at the balance sheet a compared to a monthly balance, she first you would have seen it. So if you just pick up the income statement, you know, you’re taking a big risk, especially with interim statements are not subjected to the same, you know, uh, process and quality assurance process that your end statements are. Hire A CFO Edmonton to help you with this. So you want to look at that balance sheet first cause and it has some comfort with it because it gives you more, um, you know, gives you more certainty that that profit and loss statement that you’re making significant business decisions on is correct. How does looking at a six month comparative profit and loss statement.
So we always, you know, suggest when reviewing these interim statements that we’re looking at a six month comparative in for a couple of reasons. Number one, it’s going to give you some comfort that the information is correct and reliable because if we’re looking at six months, you know, you can see, you know, any anomalies in terms of variations from month to month. Maybe the revenue is way different or you know, we have a utility bill and it’s completely different than it wasn’t every other month. If you just look at one month, it’s, those errors are a little bit difficult to uh, you know, determine. Um, so, but if you’re looking at six months, usually those errors become really clear really quickly. So, you know, I encourage people to look at that six month comparative to the probably the second reason is maybe there’s no misstatement and all but there’s really something different that’s occurred in that month. If you Hire A CFO Edmonton it is good that they know how to break down this statement.
You know, we didn’t incur this expense that we normally incurred or we have a onetime expense so maybe the net income doesn’t look so good but you know, next month especially to be pretty good because we had this one time expense that’s not going to occur. So Tho those six month comparative, I normally do that, that sets the threshold. You can usually that on one screen shot and people who can do some, you know, really quick and really powerful analysis based on that six month comparative. How can having too many income statement accounts be countered. Yeah. And this is a real common one. When people think that they should have an income statement account for everything. A um, you know, you want to boil down your incomes, they into a one page item. That’s not to say that you can’t have subaccounts or you can’t run filter reports based on items to get more specific when need be.
But that needs to wind up into a one page report at the end of the day because that one page should be your powerful decision maker in guiding your decisions. If it’s too long, you know, it becomes an unnecessarily complex tasks. You know, we have giant public companies and they have a lot of detail that goes into their profit and loss and a lot of sub accounts and a lot of classifications in the background. But then are they whined giant public company, uh, income statements and profit and loss statements into one page. Staying in contact when you Hire A CFO Edmonton is important. And if you can’t, and there’s a reason why is because that becomes a powerful decision making tool. Um, and if, if you can’t do it, you know, it’s, it’s not great. Also, it tends to be when you have all these different sub accounts that your classification is incorrect. You know, let’s say you have a utility bill in one month, you clared as a phone bill. The next month you declare it as utility and the next month and you cleared his cell phone, you look at the comparative from month to month and it looks like I’m saving money or spending more money in that. But really nothing’s changed. It’s just the way you’ve classified it as changed. So when you’re trying to compare historical, you know, variances, the analysis can be off doing dependent on how many sub accounts you have because it’s more, the more accounts you have, the more difficult it is to be consistent in the classification. Why should you or your income statement?
Yeah, so usually income statements are either organized, you know, you always have the revenue up top, it costs to sales next and the general expenses. But in those general expenses or even the costs of sales, uh, you know, you can do alphabetically or numerically sanding. Neither are wrong. But I, I just think numerically, the sending, you know, draws your attention to what you need to do. Um, because in most businesses you have your revenue, you have your cost of sales, and then the general expenses that you have. Normally you have a, you know, cost for administrative staff. You have a, a, a cost for rent and a lot of other businesses, all of the other overhead expenses, uh, they don’t make, uh, you know, uh, they don’t amount to a pile of beans. This, I’ve heard someone say in terms of if you’re going to make money or not, even if you were able to eliminate all of your other overhead costs by 50%, if you can’t do anything about that, that, uh, staffing, you know, payroll problem or if you can’t generate more revenue or you know, if your space costs too much, you never gonna make any money. This is why it is so important to Hire A CFO Edmonton that can help you.
So it draws your attention to the most significant items up top. So, you know, we know how to allocate your time as a business owner. You know, these will make the biggest difference on my bottom line and the ones down here, they’ll make it a little bit of a difference, but not as much. So that’s why I think they’re important. Let’s organize it in order of importance. What is the difference between
direct costs and general expenses?
So the, the direct costs, these are normally costs that are only incurred as a result of doing the work. So let’s say your a contractor for example, um, you know, these are the costs of the sub trades on the job and the materials on the job. So if you didn’t have this job, these wouldn’t have occurred. They specifically are directly related to that job. And if that job didn’t exist, these costs wouldn’t exist. Um, and you know, let’s say, give you another example. If you’re a dentist and you have an associate doctor and you have some high hot hygienist and let’s say you, you, you only pay that associate doctor based on a percentage of their billings, um, you know, that is a direct cost. That costs would not exist if they didn’t have that revenue as opposed to the general costs. These are generally cost that their overhead costs that you know, you’re, you’re probably going to have them whether the revenue occurred or not, they’re an overhead costs of the business. So in ones are going to, you know, very, uh, direct costs are going to vary a relative proportion to the revenue where the overhead costs, a lot of times they’re going to stay relatively the same unless you make structural changes in your business or changes to your, your processes are set up, but it’s not really the amount of revenue that’s driving them.
Why is it important to consider the percentage of revenue when analyzing drink coffee?
Yeah. So you know, just because your direct cost went up in a month, that’s not necessarily a bad thing. I mean, you did 5,000 or $10,000 of revenue one month and next month you do $20,000 of revenue. Um, and you look at your direct costs while month or five and next month or 10. It’s not that your costs were out of control. In fact that your, your, your direct costs were still 50% of your revenue. So we would expect them to go up, you know, relatively in proportion to the revenue. So what’s, rather than, if you’re analyzing how efficient your direct costs are, looking at the aggregate value can be very misleading. But looking at those direct costs as a percentage of the revenue, that’s a very powerful number that will tell you for being more or less efficient.
But what’s the difference between gross profit
So the gross profit that we have and they’ll, we’re really just looking at the revenue less the direct costs. So we’re not really taking into account the overhead of the business. We’re just looking at what were the direct costs that it actually took to get the job directly, get that job done. Uh, and that’s your, your gross profit. And then we have net income at the bottom is what we make or we lose. Um, you know, after we take those overhead costs into account.
Why does a negative number on the income statement often on?
So normally if you’re looking at revenue, that’s a positive number. You want me, you don’t have negative revenue, uh, you know, cost of sale. Same thing as if we pay a supplier. WHen you Hire A CFO Edmonton they can help you with this. We don’t pay a supplier a negative amount. We pay them an actual amount. So normally if you’re looking at your income statement, you see a negative amount that should jump out to, you know, what really happened here? Was it some sort of timing air and nine times out of 10 it’s probably a misclassification and lots of times it’s no, the classifications are very similar where let’s say we bill for supplies and we also have an expense account that supplies and that bill that you know that went to the invoice to the client, we charge them for supplies, we posted it to the expense account in which gets as good show up as a negative number. So you know, whenever you’re looking at your income statement, you see a negative number and a month to month comparison, you’ve really got to know what that negative number is because nine times out of 10 it’s a mistake.
Why is it important to separate the owner salary from all other expenses?
Yeah. The owner salary is generally a tax decision and it’s based more heavily on what’s an efficient tax treatment, where it should be based on what’s an efficient tax treatment for the owner’s household, not as a factor of what they did it all in the business. You know, you’re so, um, you want a way to separate the owner salary from the activity of the business. And what we want to do is want to boil down to a number on what does that business make before pays the owner and then what that business make after it pays the owner. Because often that owner salary, you know, has nothing to do with the business activity and everything to do with the owner’s personal circumstances or wait a mitigate taxes. Um, so you, you don’t want to use that on her salary when you’re analyzing the performance and the effectiveness of the underwear
business. Why do asset purchases not belong in the profit and loss it?
Oh, the, the asset purchasing was tiny principle. So what that means is you don’t want to wear the matching principle story. And what that means is we want to match the expenses to the revenue. So we want to have the expenses that were used to generate that revenue match in the same period. You know where that revenue actually occur. So if you go out and buy $100,000 piece of equipment that you’re going to use for the next 10 years, you don’t have $100,000 expense in the month that you bought it. You have $100,000 expense that should be depreciated or amortized over that 10 year period. They don’t belong on the ink of the statement because it’s going to cloud what you know, your performance on that month. And I’ll make that month look brutal. Even though that month could have been your best month ever and it just had a, a large capital purchase or equipment purchase that we’re a piece of equipment. There were needs for 10 years.
Should the principle portion of a loan payment up here on the income statement?
No, the principle portion of the loan payment should not appear on the income statement. The interest, uh, belongs on the profit and loss. And with the principle portion should be on the balance sheet. Should it should be reducing the loan balance over time, then it’s important to know, you know, is this business hamstrung by the value of the loan payments? And you know, if we were able to restructure those loans, get a longer amortization period. Could we correct this business or does the underlying business make no sense even if the corporation had no debt. That’s the, the the important part. So you know, they don’t belong. Principle portion of loan payments don’t on the income statement, USB interest portion as an expense of the business shed. You also review a year to date versus prior year profit and loss statement. Yeah. So usually you’re looking at your, uh, prepared a monthly income statement.
We call it six months, comparative six months compared to balance sheet six months compared to the income statement. Start there. Um, now once you have some comfort on that month, a month statement, which really points out the variances, you know, where do we have any differences in performance are a possible misstatement. And once we moved past there, usually I’ll encourage people to go to that year to date balance at year to date income statement. So what you’ve made, and let’s say you have a December year end and now we’re in March and we’re looking at, you know, what happened January, February, this year versus what happened in January, February last year. Because just looking at the last two months can sometimes ignore a lot of businesses, have some seasonality, they have busy seasons, they have slow seasons. When looking at your season, make sure you Hire A CFO Edmonton to assist. So what did this season this year looked like to the same season last year. Now we start to get a real good roadmap on what the performance of our business is that we wouldn’t necessarily get if we were just looking at, you know, uh, Ganja in February, next to November and December.
There might be something vastly different about the, the timing of that business. So I usually like to look at six months comparative a income statement or profit and loss statement, same thing, and then look at a year to date, uh, income statement versus the year to date in the same period in the prior year. Um, so that’s what we have today. You know, thanks so much for joining us again, as always, you know, if you could hit the like and subscribe buttons so we can continue to deliver you tips on how to beat the odds at business. And do you have any questions that you’d like answered here? Will feel free to leave them in the comments below and we’ll do our best to address them in a future video. Thanks very much.