Financial Statements Every Startup Should Know: Part 2
As a startup founder, it’s essential to keep a tight grip on your company’s financial performance. In addition to attracting investors, a vital part of running a successful startup is ensuring you stay above water financially. Therefore, assessing your financial health regularly and taking corrective action if necessary is critical. That’s where the profit and loss statement, also known as the income statement, comes in handy.
The profit and loss statement, also known as a P&L statement or income statement, is a financial statement that outlines a company’s revenue, expenses, and net income or loss during a specific period. It’s an effective tool for analyzing financial performance and determining whether a company is profitable.
According to Small Biz Trends, 31 percent of businesses fail within 2 years, and a survey conducted by CB Insights recently found that approximately 38 percent of startups fail because they run out of cash.
Without a clear understanding of your financial performance, you could be another one of these statistics before you even realize it. But with a solid grasp of the P&L statement, you can steer your company toward profitability and success.
This article will explore the profit and loss statement and why every startup founder should understand it for the future financial well-being of their company. We’ll explore the key metrics used in a P&L statement, how to create one, and how to analyze it to make informed decisions for your company’s financial future.
What is a profit and loss statement?
Also known as an income statement, a profit and loss statement is a fundamental financial statement that displays a startup’s financial health by reporting the company’s assets and total income alongside its total business expenses.
This statement enables startup owners to quickly evaluate their core operations’ financial performance over a specific period. This report documents crucial information on the startup’s profitability, allowing the owners to understand whether the business generates profits or losses.
Here are the standard components of a profit and loss statement:
- 1. Revenue (or Sales): This represents the total amount of money generated by the company from the sale of goods or services. This figure is crucial because it reveals the effectiveness of a business’s sales strategies and shows if the company is growing, stagnating, or declining.
- 2. Cost of Goods Sold (or Cost of Sales): This is the amount of money a company spends on producing or purchasing the products it sells. This component encompasses the costs incurred in the manufacturing, producing, and distributing of goods or services. It also includes direct labor, materials, and overhead costs.
- 3. Selling, General & Administrative (SG&A) Expenses: This reflects the expenses incurred in running the core operations of a company, including the payroll, rent, utilities, insurance, and other costs associated with the day-to-day operations of the business. SG&A costs are critical since they can have a significant impact on a company’s profit margin.
- 4. Marketing and Advertising: This category includes costs associated with promoting a product, service, or brand. These expenses can be used to buy advertising space in print or online, sponsor events, or create promotional materials such as brochures or billboards.
- 5. Technology/Research & Development: This component reflects the costs incurred in developing and implementing new products or services and improving existing ones. Expenses can include research and development, patents, copyrights, and licensing fees.
- 6. Interest Expense: This is the cost of borrowing money to finance a company’s operations. Interest expense includes the interest paid on loans, bonds, or other debts.
- 7. Taxes: This is the amount of tax payable to the government based on the company’s income for the period. Taxes are an essential component of the profit and loss statement since they can have a significant impact on a company’s overall profitability.
- 8. Net Income: This represents the final result of the profit and loss statement, showing the total profit or loss of the company after all expenses and taxes are deducted from revenue. Positive net income indicates a profit, while negative net income indicates a loss.
Profit and Loss Statement vs. the Balance Sheet
While both the Profit and Loss (P&L) statement and Balance Sheet are important financial documents, they have different purposes. The P&L statement outlines a company’s revenues and expenses over a specific period, such as a month or a year. It shows how much revenue the business has generated and how much it has spent to create that revenue, resulting in a net income or loss for the period.
The Balance Sheet, on the other hand, provides a snapshot of a business’s financial health at a specific point in time. It lists the company’s assets, liabilities, and equity. It helps track the company’s investments, debts, and equity balances. Understanding the differences between these two financial statements can help small business owners manage and monitor their finances more effectively.
Profit and Loss vs. the Cash Flow Statement
It is also necessary to note that the P&L statement is not the same as the cash flow statement, although both are essential financial statements for any business. The cash flow statement shows how much cash is coming in and leaving the company, while the P&L statement shows the business’s revenue and expenses. A clear understanding of the difference between these two statements will help business owners make informed decisions about managing cash flow differently from expenses and income.
The cash flow statement shows how much cash is coming in and leaving the company, while the P&L statement shows the business’s revenue and expenses. A clear understanding of the difference between these two statements will help business owners make informed decisions about managing cash flow differently from expenses and income.
The Importance of the Profit and Loss Statement for Your Startup
The profit and loss statement is a crucial financial statement for any startup. It provides a comprehensive insight into the company’s financial position by detailing revenues and expenses over a specific timeline, usually a fiscal year.
Here are the primary reasons it is pertinent for your startup or business to understand this specific financial statement:
Determining Profitability
One of the critical functions of the P&L statement is to determine profitability, as it represents a snapshot of the income earned and expenses incurred within a given period. A thorough analysis of this statement assists business owners in assessing their company’s profitability, highlighting key areas where they should trim expenses or work on increasing revenue.
Improving Decision-Making
Startups often use P&L statements to assess their financial health and make data-driven decisions. In addition, it is an essential tool for tracking the business’s performance, which allows the founders to adjust their strategies accordingly.
The P&L statement can provide information to potential investors, lenders, or creditors, which will assist them in making informed decisions about investing in the business.
Conducting Comparison
Profit and loss statements may contain ratios highlighting crucial aspects of the business, including gross margin, operating margin, and net profit margin, allowing owners to compare their performance to that of competitors in their industry.
Boosting Costs
When reviewing the document regularly, owners can identify ways to improve revenue, minimize expenses, and manage cash flows that ultimately lead to improving the startup’s bottom line. This could involve reducing expenses in certain areas or finding ways to increase revenue streams. Additionally, this can help businesses forecast future earnings and expenses, which can be critical for budgeting and planning purposes.
Maintaining Transparency
A profit and loss statement gives business owners an accurate and transparent view of the startup’s financial position, the first step in creating a solid financial plan for your business’s prosperity. Transparency is crucial in building trust and credibility with investors and stakeholders. A P&L statement can help startups present a clear and accurate picture of their finances, enhancing transparency and showing that they have nothing to hide. By sharing regular P&L statements with investors, startups can ensure that they know the company’s financial situation, which is essential in building strong, collaborative relationships.
Ultimately, the profit and loss statement is integral to every startup’s financial management. It provides valuable insights into the company’s financial position, helps to measure performance, and makes informed decisions.
By creating and analyzing the P & L statement, startup founders can identify areas that require improvement or attention, enabling them to steer the business toward the desired financial outcomes. A successful business continuously monitors its financial position, and the P & L statement is a great tool to achieve this objective.
How to Create a Profit and Loss Statement
As a startup founder, you must create profit and loss statements to understand your company’s financial health better. With a P&L statement, you can quickly identify your business’s revenue and expenses for a specific period. Doing so will help you make informed decisions about your business operations and costs.
Creating a P&L statement is easier than it sounds, especially since there are several tools available for you to use. Most accounting software comes with pre-built templates for financial statements that are easy to use. You can also find a free template online to help you create your P&L statement hassle-free.
To accurately assess your financial standing and prepare a profit and loss statement, you’ll need a few things:
- You will need a record of all incoming revenue. This encompasses all sources of income, such as checks and credit card payments, which can typically be found on your bank statement. It’s important to note any reductions to sales as well, such as discounts or returns.
- After you’ve recorded your revenue, it’s time to calculate your cost of goods sold (COGS). COGS is the total cost incurred to produce the goods or services you sell. It includes all direct costs of producing your product, such as labor, materials, and packaging. Subtracting your COGS from your revenue will give you your gross profit.
- Lastly, it would help if you calculated your operating expenses, such as rent, utilities, salaries, and marketing expenses. These expenses are not included in COGS and must be subtracted from gross profit to determine your net profit or loss.
Remember to keep all receipts and invoices for any expenses incurred by the business throughout the year. Creating a P&L statement regularly is an excellent way to keep track of your business’s financial health and to make informed decisions to grow the business.
How to Analyze a Profit and Loss Statement
The profit and loss statement is an important financial document that summarizes a business’s revenues, expenses, and profits or losses over a specific period. Because this statement plays a critical role in the financial management of any startup, it’s essential for founders to understand how it works and know how to analyze it.
Understand Essential Accounting Principles
One of the first steps in analyzing a profit and loss statement is understanding the underlying accounting principles used in its preparation. For instance, the statement follows the accrual accounting method, where income and expenses are recorded when they’re incurred rather than when cash is received or paid out.
This means that even if a business has yet to receive payment for products sold or paid a supplier for services rendered, the income or expense will still be reflected in the statement for the accounting period it was earned or incurred.
Conduct a Break-Even Analysis
Another important aspect of analyzing a profit and loss statement is to conduct a break-even analysis. This type of analysis helps startups determine the level of sales and revenue needed to cover their costs and operating expenses.
Looking at the profit and loss statement with a break-even analysis can help founders understand whether their operations are profitable and, if not, what changes must be made to achieve profitability.
Examine Your Costs
Finally, when analyzing a profit and loss statement, looking at the operating expenses or costs associated with running the business is essential. These include salaries, rent, utilities, other overhead expenses, and more.
By comparing the operating expenses to the operating income, startup founders can determine how much of their revenue goes towards overhead and how much contributes to profits. This information can help them decide which expenses to cut or increase to improve profitability.
Final Thoughts
Understanding the profit and loss statement, or income statement, is crucial to running a successful small business or startup. This financial statement provides insight into the company’s revenue, expenses, and net income over a specific period. By paying close attention to this statement, business owners can identify areas where they can cut costs, increase revenue, and ultimately improve the bottom line.
It is also important to note that the profit and loss statement is not a one-time document that companies create at the end of the fiscal year. Therefore, small business owners and startup founders should monitor this statement regularly to track the company’s financial performance. By doing so, they can make informed decisions that will keep the business healthy and profitable.
How MAccelerator Can Help
If you are a startup founder needing assistance with creating a clear strategy, sourcing funding, and developing a go-to-market plan, consider joining one of our online accelerator programs offered by MAccelerator.
MAccelerator offers a virtual, hybrid accelerator and incubator program that provides startups with invaluable guidance and resources to help them navigate the challenging terrain of launching and growing a startup. Through our online programs, startups can work closely with a team of experienced professionals who specialize in business, marketing, pitching, and growth hacking. We provide a comprehensive suite of tools and services to help startups create a clear strategy, generate traction, and develop a successful go-to-market plan.
Joining our program can be an excellent way for startups to advance in today’s competitive business landscape. By working closely with expert mentors and leveraging a structured process for business development, startups can generate traction, validate their ideas, and pitch to investors with confidence.
