As a business owner, you want to know how your business is progressing financially. Looking at a financial statement without any other point of reference has little value. Profit and Loss Statement Analysis begins with an understanding of the flow of the report. In this article, we will see some of the ways to effectively evaluate your performance using your Profit and Loss Statement (P&L).
Every business that I know of desires to grow profits. When you look at a P&L for a given time period, you can’t really tell if you are growing or not. One way to measure growth is to compare one financial period with another. This is called a horizontal analysis. A very common layout is to show current month, same month last year, year-to-date, and year-to-date last year at the same time. The layout may look something like this.
By focusing on the delta columns, you can quickly identify whether you are doing better or worse than the prior period. Typically, the formula for the delta will be written so that if you have improved from the prior period, it will display a positive number whereas if it is a worse (lower revenue or higher expenditure) then the result will be a negative number. Knowing this format, you are able to quickly browse the report and find areas where you have done well and those where you are having trouble. The horizontal analysis is a very effective way to evaluate your performance over time.
Using the horizontal analysis tells you how you are doing compared to another time frame, but, it does not present enough information to tell you what contribution your sales are making to the bottom line. The vertical analysis of the income statement is another simple approach to examine your results. The most common presentation of a vertical analysis is to present all of the numbers as a percentage of gross sales. The simplified statement below illustrates a vertical approach.
These analyses become even more powerful when you combine the horizontal with the vertical analysis. In this case, you have two comparison periods along with a percentage of gross sales for each period. With both formats combined, you can see growth and efficiency at the same time. Below is a sample of the combined approach.
This is a simplified and quick way to review a profit and loss statement analysis. In another article, we’ll explore how various financial ratios can shortcut much of the detailed analysis and give you health readings for various aspects of your business. SAP Business One is an ERP solution for small and mid-sized companies.