There are two essential financial statements which every small business owner should be familiar with – the balance sheet and the profit & loss statement (sometimes referred to as an income statement). These documents are crucial for business owners to assess the financial health and profitability of their business.
The profit & loss statement summarizes a company’s financial activity over a specific time period and is categorized into two main components – income and expenses. The bottom line of this document will either be a positive figure or a negative figure, based on the total income and expenses for that period of time.
Many small business owners do not break down their income and expense categories in a way that is beneficial to analyzing the individual components of their operation. Generally, income is lumped into one large account such as gross sales, and expenses are simply listed out in alphabetical order with every different type of expense mixed together.
Organizing the elements of your profit & loss statement will provide comprehensive insight into how the various departments or divisions of your business are operating. Instead of viewing the income as a total number (gross sales), consider creating separate income accounts for each department or division.
Similarly, expenses could be grouped according to the type of expense, such as variable expenses (i.e. marketing, freight, packaging, sales salaries or other product/service types of expenses) versus fixed expenses (i.e. rent, insurance, administrative salaries, utilities, etc.). By categorizing expenses in this way, the business owner can assess the changes in the variable expenses over a series of months or years and compare those expenses to the income received over those same time periods. Without this breakdown, an analysis would be impossible.
You can further organize the elements of your profit & loss statement by categorizing your expenses according to the specific type of expense with the use of sub-groups. An example of a group would be automobile expenses. In this group, you could create sub-groups for auto insurance, auto repairs & maintenance, and auto leases. Another example of a group would be travel expenses, with sub-groups of airfare, lodging, parking, and meals. The goal of these sub-groups is to consolidate your expenses into related groups for financial assessment and tax reporting purposes.
In the end, there are multiple ways to effectively organize your profit & loss statement. Each business owner must understand what they ultimately want to retrieve from this document in order to establish a system through their Chart of Accounts to reach that objective. Carving out time in your busy schedule to do so is another matter entirely.
With offices in Williston and Rutland, Vermont, Davis & Hodgdon has been assisting small business owners with bookkeeping and financial reporting organization for more then 25 years. For more information please call 802.878.1963 (Williston) or 802.775.7132 (Rutland) or email [email protected].
For more information about the importance of financial reporting to your small business please visit: http://dh-cpa.com/client_media/files/pdf/Managing-Small-Business-Finance.pdf.
Article by Martha Leonard, Bookkeeper and Tax Preparer, Davis & Hodgdon Associates CPAs