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 Red Flags
Here we define what P&L management stands for
We will be covering in details :
- P&L Definition
- P&L Management Explanation
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, packaging costs, tagging & barcoding costs..etc.
3. Gross Profit: Revenue – COGS
4. Gross Margin: (Gross Profit / Revenue) x 100
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,
- Selling & Promotion Expenses: Marketing, advertising, credit
card fees, windows and in-store print materials
- Misc: Any other expenses related to stores and was not recorded
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.
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?
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.
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 (see also red flags below). 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?
In this chapter we will cover the pillars of P&L management
We will be covering in details :
- Managing Revenues
- Managing Costs
At the top of the P&L statement comes “sales” or “revenue”. This is a main figure, from which all the upcoming lines will be subtracted.
A business can have a single source of revenue, for example store sales, or it can have multiple sources of revenue. Businesses that have multiple sources of revenue can include normal sales of goods besides subscription offerings for value added services for example.
It could also have the same type of revenue but under different brands. For example, the statement for The Gap below shows “consolidated” statements of income, because The Gap as an entity has subsidiaries under other names and this is the collective statement for the entire business.
Managing a sales team and a sales function starts with understanding the KPIs that are given for this team and actively driving them.
1. ATV: Average Transaction Value
ATV measures the average value of each transaction (in $).
If we sold for 20,000$ in a day and had 10 transactions then the ATV will be:
ATV= 20,000$ /10 = 2000$
2. IPC: Items per Customers, sometimes also called UPT (Units per Customer)
IPC measures the average number of items each customer bought
If we sold a total of 1000 units in a day and had 20 transactions (i.e 20 customers) then IPC will be:
IPC = 1000/20 = 50
3. Conversion: Conversion measures the percentage of customers who bought from the number of customers who entered the store
If we had a traffic of 1000 customers and only registered 33 transactions our conversion would be
Conversion = (33/1000) x 100 = 3.3 %
Now that you are aware of how to calculate the main KPIs of a retail business, let’s find out how we can use those KPIs to drive sales.
HOW TO MAXIMIZE SALES?
Up-selling is when a customer is buying a product of certain specifications and you convince them to upgrade the same product but with higher specifications and of course higher price.
A customer buying a 50 ml perfume bottle and you convince them to take the 100 ml.
Up-selling typically increases ATV, but would not affect IPC or conversion
Cross-selling is when a customer is buying a certain product and you convince them to take complementary products from another category as well.
if someone is buying a mobile phone, you tell them to also buy the accessories for that phone.
Cross-selling would increase both ATV & IPC
Add-ons are typically small value items placed in display at the end of the shopping journey, so that they can be added to the transaction last minute.
Examples of these are the gum and candy displays at the checkout in the grocery stores.
The idea is to add something small that the customer was not planning to buy in the first place, but because you suggested it they took it. Usually it works when the cashier suggests those things, and if done on a scale they can add a sizable value to the sales at the end of the day.
Add-ons increase IPC and slightly affect ATV.
Tip: Think about some competitions to run between stores, that will help increase ATV & IPC.
3. Improving Conversion
Increasing conversion is when you make more of the people entering the store buy anything instead of exiting without buying.
Increasing conversion will have a big effect on your sales; much bigger than the other methods.
That’s because you are not only adding one item, but you are adding a whole new customer and you will also benefit from the lifetime value of this customer.
4. Driving More Traffic
Besides managing the business in a way that maximizes revenues, without harming the brand on the long run, the manager has to also minimize costs- also without harming the brand on the long run.
Costs come under different classifications based on the source of that particular cost. Some costs are product related, some are operations related, some are financial.
Costs also are of different types in terms of being fixed vs variable. Business managers should be able to identify the different types of costs and how to minimize them in a reasonable manner.
Some costs can be minimized by downsizing a certain cost area to the minimal that is needed to operate the business. Other costs can be minimized by being consolidated or centralized.
HOW TO MINIMIZE COSTS?
1. Managing Staff Productivity & Headcount
The highest costs in your P&L are usually your staff costs and rent. Your staff cost should always be relative to your sales, usually 8-10%. If you are above that value, then you need to find ways to bring this cost down.
This could include:
- Effective retail scheduling
- Sharing staff between stores
- Hiring part timers
- Hiring temporary staff for event days only
- Monitoring & controlling overtime
2. Controlling Shrinkage
Shrinkage , aka stock loss, is the inventory that goes missing from stores and warehouse due to internal, external thefts & administrative errors.
It is a very low hanging fruit that can be fixed with a good, strict system in place. You should already be having a CCTV system in the store, stock room and warehouse.
There should also be a spot check mechanism done regularly on the cash register, the locker and the staff.
It is important to mention here also that a significant amount of stock loss is due to admin issues, such as receiving/scanning errors or transferring stock from one store/location to the other. The more you minimize the stock movement between locations (or back to warehouse) the lower your shrinkage will be.
3. Growing & Keeping Talents
Developing talents should already be one of your pillars, because when people feel engaged and hopeful they give their all to their job. You will find that growing talent will not only benefit your team but it has a tremendous effect on your cost management.
The costs of hiring and training new staff, especially managers, are very high, and when you are developing from within you will be saving big and at the same time affecting peoples’ lives.
The effect of this on cost management is actually double! That’s because when you grow your managers and give them a sense of ownership to the business they will act like owners. They will be up to it!
You will be surprised to find them saving even more money for the business on the daily operations of the stores. All this will add up, together with the savings you achieved from not hiring new talents from outside.
4. Switching to Digital Marketing
Digital Marketing can reduce your customer acquisition fees and advertising expenses tremendously when compared to traditional advertising methods. Of course it depends on your products and types of customers, but these days digital marketing works for almost everyone.
- Make sure to have a website, social media accounts and an e-mail list.
- Add your local business to Google and optimize your site for local SEO.
- Hire one person to manage all those and see how this will bring new customers to your doors, at fraction of the price.
You will still need to do paid online advertisement from time to time, but even this is cheaper than print media, billboards and other old methods. That’s because online ads can be highly targeted for your specific audience, so you can get more results for your ad spend.
5. Negotiating terms with suppliers & vendors
Minimizing your costs include costs of goods. You always want to make sure you are getting the best price and best terms for your orders.
Also note that suppliers will never give you the lowest price first. They actually expect you to negotiate and then negotiate some more. Not only the price of the item, also negotiate shipping terms, payment terms, everything!
Do not only negotiate with suppliers of your products, but also landlords, vendors who give you services like printing for the marketing materials, or making your shopping bags. Negotiate every single cost line for your business – except maybe for small costs that are not worth your time & effort.
You will find that negotiation alone will save your a lot of money quickly and the results will soon show on your P&L.
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In this chapter we will discuss the importance of P&L management
We will be covering in details :
- Importance of P&L management
- Different Scenarios
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.
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.
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.
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!
P&L Red Flags
Here we will show certain signs of trouble that can be spotted in a P&L statement
We will cover:
- P&L Red Flags
P&L MANAGEMENT RED FLAGS
Now that you’ve become familiar with reading a P&L statement and knowing how to act on the information in it, let’s see some hidden red flags that you should be aware of.
This is important especially for business owners who have other people managing their businesses and only monitoring the financial statements every month/quarter.
You can find out a lot about the type of management running a company just by reading the financial statements.
1. Very High Revenue/Sales with Very Low Margins
If you are seeing a big jump in sales over last year always look at the margins. If the increase is in revenue only, but the margins are lower than last year, then the management have resorted to excessive discounting to bring those numbers in.
They might have had valid reasons to make these discounts, such as stock piling up and they need to clear it. But they might have also resorted to this only to achieve the sales and profits targets and get their bonus for the year.
Why is it bad if they are going to achieve the targeted number anyways?
Let’s look at an example with number
Sales in 2017: 100,000 $ at 50% margin. So the gross profit is 50,000 $
Sales in 2018: 200,000 $ at 30% margin. So the gross profit is 60,000 $
At the first look, this sounds like a fantastic result! 100% growth in sales and 20% jump in gross profits and also of course net profits.
You will come to find the next year, that this is not the case, because these sales didn’t come normally, but rather under exceptional circumstances that are hard to be maintained and can actually be detrimental to your long-term business.
When customers keep seeing a lot of offers and discounts on your products, they will stop buying at full price and will start to wait for the sale. Gradually you will find that you are not able to drive any traffic without giving them that incentive and so your business would have entered into a downward spiral of discounts that will affect your profitability on the long run.
2. Exceptional Costs
Anytime you see a sudden increase in cost over the last few years, you need to get detailed explanation from the management about those cost lines.
Normally, any exceptional costs should be reported in the footnotes of the financial statement, but if not, you need to seek more information on that. Find out if this is a one-time cost or will be recurring in the future, and why is it that this line is costing us so much more now vs in the past.
Your company was getting marketing services from an agency at 30,000 $ a year. This has been the case for 4 years now. However; this year in the P&L you found your marketing services costs have jumped to 50,000$. Your expectation for marketing costs were to go higher, but only by 2-5%, and this is the budgeted amount, but not more.
You dig deeper and find out that the business has switched vendors and the new vendor costs 50K for giving the same services.
Here there are usually two scenarios:
- Either the company does charge much higher and in this case you would want to see if they are providing superior services to the previous vendor and whether or not it is worth the difference.
- The company has actual lower rates than the ones billed to the business and in this case it should be investigated why your company is being charged higher.
This advice does not only apply to business owners. Retail Managers should be doing the same with their P&L. Investigate every cost line, especially the ones showing high increases on previous years.
At the end of the day, maximizing profit for the business is your KPI and you need to be delivering on that.
3. Artificially Low COGS
Companies can artificially reduce their COGS amount in their P&L. This can be done by inflating the value of their inventory, overstating the discounts they get from suppliers, not writing off their obsolete stock or even straight-out changing the stock level reported at the end of the period.
This will result in higher gross profit margins and hence also higher net profits.
To identify such situation the business owner or investor is advised to monitor the level of inventory over a longer period of time than the time reported and compare to see if anything is unusual, e.g fast inventory buildup without justification.
The income statement is one of the most important financial statements that gives a snapshot of how the company is performing and also how it is managed. That’s why it is essential for managers and investors to understand how to read and analyze a P&L statement and how to actively manage the P&L of the business.
The income statement has to be combined with the other financial statements to give the full picture.
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