P&L MANAGEMENT
The Complete Guide
This is a complete guide to P&L management
You will learn about:
- P&L Definition
- P&L Importance
- P&L Management & Business Health
P&L MANAGEMENT DEFINITION
P&L management is analyzing and interpreting the P&L statement of the business, and taking corrective actions when needed, with the main goal of maximizing net profits at the end.
In this guide we will explain in full details, with example of a retail business, what P&L management is all about.
WHAT IS P&L
P&L is short for “profit & loss” It is also referred to as the “income statement” of the business.
At the end of each period (month, quarter, year) the business generates a set of financial statements that show a clear picture to the management and business owners on how this business is performing and how, if you know what to look for, it is managed.
The P&L statement lists all the sources of revenue and all the different types of expenses, so at the end of the statement it shows the net profit for the business.
P&L STATEMENT COMPONENTS
Multi-Store P&L Template
1. Revenue: Total Sales of all categories for a certain period of time.
2. COGS: Cost of Goods Sold.
The cost of the items sold within a certain period of time. This includes their shipping costs (from supplier to your warehouse), packaging costs, tagging & barcoding costs..etc. The costs invested into the product until it is ready to be sold at your store.
3. Gross Profit: Revenue – COGS
4. Gross Margin: (Gross Profit / Revenue) x 100
Example:
If we sold products for 100,000 $ and they cost us 40,000 $ to source. Gross Profit = 100,000$ – 40,000$ = 60,000 $
Gross Margin = (60,000$/100,000$) x 100 = 60%
5. Retail Overheads (or Operating Expenses)
- Staff Cost: Includes salaries, incentive, indemnity, pension, health insurance,..etc.
- Rent: Store Rentals and Mall service fees
- Admin Expenses: Include electricity, municipality, telephone,
internet, ..etc. - Selling & Promotion Expenses: Marketing, advertising, credit
card fees, shopping bags, windows and in-store print materials - Misc: Any other expenses related to stores and was not recorded
above
6. EBITDA: Earnings Before Interests, Taxes, Depreciation & Amortization
This is calculated by subtracting the Retail Overheads (or Operating Expenses) from the gross profits (The template calculates it automatically)
7. Depreciation: Depreciation is accounted for when you purchase any asset for the business that is expected to depreciate in value over time.
For example the cost of building the store and the equipment (assets) in the store will be accounted for over a period of ,say, 5 years (based on 20% depreciation per year).
Each year will be billed a certain amount that is equivalent to 20% of the total cost.
Example:
It cost you 100,000$ to build the store, including the equipment and fixtures. This amount was recorded as CAPEX (investment) in your balance sheet & cash flow statement at the beginning but was still not billed to your income statement.
You will assume 20% depreciation per year and bill 20,000$ every year to this store’s P&L.
This 20,000$ will be divided on 12 and recorded every month in the P&L.
8. Store Level Profit: This is profitability at store level, without accounting for out-of-store expenses, such as office employees and warehousing fees (common costs shared between stores).
If you are managing multiple business lines that share common expenses, this is the (pre-tax) profit at business line level.
It is beneficial to calculate profit at this level, before final profit, to see if the store/business line is profitable on its own or not. This is used later on while making decisions on opening or closing locations.
If the store on its own is profitable, but after adding common costs it is in loss, then there is a chance for this store to become profitable with expansion, as opening more locations will divide the common costs among more stores.
If on the other hand the store is not profitable on its own and there is no room for revenue growth or cost reduction, then it is better to close this location.
Read Also: Why Are Retail Stores Closing?
9. Net Profit: Net profit after subtracting the allocated expenses related to office & warehouse and any other corporate expenses, as well as taxes.
WHAT DOES P&L MANAGEMENT MEAN?
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P&L Management refers to analyzing and interpreting all the lines of the P&L statement and taking corrective actions if needed, in order to maximize the net profit at the end of the period.
The business manager should be aware of what is affecting the profitability of his business and what are the actions that can be taken about it.
Managing P&L is all about maximizing revenues (sales) and minimizing costs in a sustainable way that doesn’t jeopardize the long term health of the business, to ultimately maximize profits at the end of the year.
P&L management is a KPI for any top level manager and most middle managers who manage cost centers. If this KPI is included in your job description, you are expected to manage the P&L statement of the business in a way that delivers the targets defined during the initial retail budgeting process.
- The step by step retail budgeting process
- Set monthly targets adjusted to seasonality
- Templates download & practice exercise
P&L MANAGEMENT AND BUSINESS HEALTH
It should be noted that, in order to be able to assess the health of a business, one should not only look at its income statement.
Other financial statements like the balance sheet has to be combined with the P&L statement to show the real picture. Also managers need to be able to manage the business, both, from the P&L as well as the balance sheet.
You have to be managing the business for the long term success. Focusing on the P&L only will keep your eye on this period, this quarter, this year. It might also drive you to neglect risk mitigation and brand value, all for the short term success you can achieve now in your P&L.
Looking at the P&L statement and finding profit at the end of the period doesn’t mean that this business is healthy. It is only when you combine the P&L with the balance sheet and the cash flow statements that you get a better picture. Then when you view these statements over a period of time (say 5 years) this gives you a better understanding of how this business is really performing.
This is because all the accumulated profits/losses will show on the balance sheet, and only the cash flow statement will show whether this business is cash flow positive or negative, regardless of profitability.
Read Also: Why Profit Does Not Equal Cash?
P&L ANALYSIS
Become a member and read our step-by-step framework for analyzing a P&L statement for a retail business or take the in-depth Retail Business Performance Analysis Course.
Learn about:
- What’s affecting your final net profit?
- What reports to generate & dig deep into?
- How to act on those reports?
IMPORTANCE OF P&L MANAGEMENT
The goal of any for-profit business is to generate profits year after year and the P&L statement measures just that.
Even if the business is not generating profit from the first year, which is typical scenario for a lot of new businesses, the P&L statement can still be used as a tool to plot down the profit projection for this business in the coming years, based on realistic estimates and indicate if this business is viable & feasible or has no chance of survival.
This assessment will boil down to whether or not the P&L of this business can be managed (through improving revenues & reducing costs) and result in turning profits.
Scenario 1
A new business might be losing money in the first year, but when you plot down the revenues for the coming 5 years and put a reasonable growth estimate (say: 5 %) for each of the 5 years, you find that the business will be well profitable.
That’s because the revenues have a very strong chance to improve and the costs are pretty much fixed and will increase only by a small amount to keep up with inflation.
Scenario 2
On the other hand, a new business might be losing a lot of money, and when you plot future estimates for revenue growth you still find that this business will continue to lose money. This is usually the case when the business has variable costs that increase with increased revenue, and they have no chance to be covered. It’s just that the economics of this business model are not working.
Example :
You launch a drop-shipping business that requires you to source an item from a supplier & then run facebook & Google ads at a certain cost and a certain conversion rate to get customers. When those customers buy from you, you pay the supplier to deliver the item directly to them and you pocket the difference.
For this business to succeed it will depend on the relationship between your acquisition costs (i.e your Facebook & Google Ads cost per click or impressions) and your conversion rate from these campaigns into a successful sale event.
Let’s assume the following:
Cost per click for Google Ad= 5$
Conversion rate = 10%
Item Sale Price = 20$
Supplier takes 10$
You run a Google Ad and get 1000 customers to click through this ad.
You convert 10% of these customers = 100 Sales Transactions
Your Revenue = 100 x 20$ = 2000 $
Your Gross Profit After Paying the Supplier = 100 x 10$ = 1000 $
Your Sales & Marketing Costs = 5$ x 1000 = 5000 $
Without even getting into the other cost lines of this business (i.e hosting, office rent, subscriptions,..etc) it is obvious that this business with these economics will never make money. That’s because every time you increase your revenue, you are going to pay even more in ad spending.
You will only know this if you plot down revenue and all the different cost lines into a P&L sheet and check if they make profit or have a chance to make profit with improving revenue.
Also there are usually benchmarks for costs like rent, marketing and staff for every industry as a function of revenue. For example the benchmark for rent could be 15% of revenue, employees 8-10% and advertising at 1-3%.
As part of P&L management you want to make sure that your numbers are within those benchmarks, otherwise you might be overspending or you might end up in a situation like the above, where your advertising costs are 5x your revenue!
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