Tag Archives: P&L

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Close- Up: Revenue and Profit

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Does the thought of managing finances more complicated than your household budget fill you with fear and loathing? You are not alone! Many share that sentiment but in the world of Freelancing, getting your arms around the management of company finances comes with the territory. Outsourcing your bookkeeping and accounting functions can be a smart move that allows you to focus on client acquisition and retention or other things that only you can do, for example, but you cannot afford to be in the dark about what’s happening with your money. You can’t plan and execute a marketing campaign or an expansion strategy until you know how much money will be available to carry it through.

You can ask your bookkeeper or accountant to suggest a reasonable budget for your plan, but it’s better if you have the answer before you ask the question. In order to know how much money you’ve got, you’ll need to get comfortable with reading your Income Statement, also known as the Profit and Loss (P&L) Statement. The P&L details all the money that is earned (sales revenue) and expenses paid, e.g., rent, utilities, professional association dues, or payroll.

Financial management is a big topic so today we’ll limit our focus to money that comes into the business—revenue—and the money that remains after expenses are paid—profit. The two categories are very similar and are frequently used interchangeably by those of us who are not accountants or bookkeepers, but there is a subtle difference between the two and it makes sense for Freelancers to grasp what each term says about your entity.

Revenue

Revenue is money generated through the sale of products and services plus other money-making activities that take place within the business. The initial tally of revenue indicates what’s been generated before expenses are deducted. Calculate revenue by using this equation:

Revenue = Price x Quantity sold

Sales generated when clients pay for your products and services, along with other income streams if applicable, is classified as revenue derived from normal business operations. However, since a business may generate revenue from different sources (income streams) it’s useful to consider each line of business separately, so that you can scrutinize how each performs. When you separate revenue by source and type you’ll quickly see which is lucrative and which is lagging—and you’ll be positioned to make smart business decisions.

So if you begin to regularly teach a class in addition to your Freelance consulting work, you can record that revenue separately, as it’s own income stream. If you also sell a tangible physical product in addition to your intangible B2B services, you can record revenue from your tangible products and intangible services separately. Or maybe you own a restaurant? If so, you’ll separate and analyze each revenue source by categorizing your menu offerings: side dishes, main dishes, appetizers, nonalcoholic and alcoholic beverages.

As well, you can separate your revenue into operating and non-operating sources. Operating revenue represents sales from a company’s core business. For instance, in a restaurant, operating revenue is derived from the sale of food and beverages to customers.

  • Annual Recurring Revenue

Another category of revenue that you would be wise to record and examine separately is known as annual recurring revenue (ARR). ARR is revenue that is associated with subscription agreements or other contractually dependable, expected revenue streams. Documenting ARR is critical because it provides companies with a predictable revenue stream. There is nothing sweeter than money you can depend on!

  • Non-operating Revenue

Non-operating revenue is sort of like selling an add-on—it’s revenue earned from sources outside of the primary (core) function. So in your hypothetical restaurant, non-operating revenue might represent sales of loyalty program cards, gift cards, branded T-shirts, or mugs, for example. Non-operating revenue might be unpredictable or mostly seasonable (associated with Valentine’s Day, or whatever) and is considered nonrecurring. Selling an asset is also categorized as non-operating revenue. Maybe you bought a non-fungible token (NFT) art work that’s now worth big money and you’ve decided to sell?

Revenue vs. Income

For an intermezzo we can also consider income, which in the world of accounting is distinct from revenue, despite the obvious similarities—-both categories mean money in your pocket. Recall that revenue represents money earned from core business operations, that is, the sale of your products and services and also ARR and money classified as non-operating revenue. Income is the money that (thankfully!) remains after all fixed (operating) and variable (sales, marketing, professional development, etc.) expenses have been paid. Income has more in common with net profit, or earnings, than with revenue.

Profit

Profit describes the total gain (or loss) of money that a business has at the close of the period (e.g., month). As is the case with revenue, there are various aspects of profit to calculate and consider. Gross profit, operating profit and net profit are three metrics recorded on your P&L Statement. In general, profit is calculated by subtracting the total fixed and variable expenses, taxes and calculated amortization and depreciation values from total revenue. Calculate profit by using this basic equation:

Profit = Revenue – Expenses

  • Gross profit

The amount of money brought in from the sales of products and services, minus the acquisition or manufacturing costs of the products or services that were sold, is known as gross profit. The number reflects the Cost of Goods Sold (product or service acquisition or production costs, including direct labor) but does not reflect the impact of fixed or variable expenses. Calculate gross profit by using this equation:

Gross Profit = Revenue – Cost of Goods Sold (COGS)

The interim assessments of profit, in addition to gross sales revenue (also called the top line) allow you to scrutinize the numerous expenses incurred between the top line (gross sales revenue) and the bottom line (net profit) and expose points of profitability weakness (i.e., worrisome expenses) in the acquisition or production of the solutions you sell, all of your fixed and variable costs and even taxation, of your business. In fact, if your top line number is strong but your bottom line number disappoints, an adjustment of COGS or fixed or variable expenses could remedy the problem.

  • Operating profit

Operating profit is the next step in the P&L progression toward the big reveal that is net profit, the bottom line. It’s similar to gross profit but includes three more categories of expenses. Calculate operating profit by using this equation:

Operating Profit = Revenue – COGS – Operating Expenses – Depreciation – Amortization

Depreciation and amortization are also values you’ll want to understand as one who manages money, even if you outsource to a bookkeeper and/ or an accountant. Depreciation reduces the actual value of equipment or vehicles due to time or use—wear, tear and age. This calculation puts a numerical value on the asset’s cost versus its operating and residual value.

Amortization refers to the value of intangible assets, such as patents or trademarks and is calculated in the same way that depreciation is calculated. Both of these accounting methods exist to spread out the cost of assets over their useful lives and provide a more accurate picture of a company’s expenses and profits.

  • Net profit

Net profit is the final assessment of actual profit and it’s calculated by subtracting all fixed and variable expenses, plus taxes, amortization and depreciation, from your total revenue. Net profit illustrates the overall health and profitability of the entity. It is the final word and is found on the bottom line of your P&L Statement. You can calculate net profit by using this equation:

Net Profit = Gross Profit – Total Expenses – Taxes– Depreciation – Amortization

Differences between revenue and profit

These very similar values are calculated in different ways and each tells a somewhat different story. Revenue reflects your company’s sales and market share growth. Profit is the company’s indicator of financial health. Another difference between these two values is the potential for fluctuation throughout the year. Revenue is prone to fluctuate from month to month because it is subject to marketplace demand which, for example, can be seasonal. In contrast, profit tends to remain more stable over time.

Finally, net profit earnings may also be known as net income or net earnings. Net earnings may be the most important number on your P&L Statement not only because it comprehensively shows the company’s total earnings performance but also, the value is carried over to your company’s Balance Sheet and Cash-Flow Statement.

Thanks for reading,

Kim

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Staying Alive: KPIs Make the Difference

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You’ll recall the overview of the 5 stages of growth that businesses of every type or size experience, if they survive, as discussed in the April 11 post. Today we’ll explore how three standard financial statements can help business owners maintain the health of their venture and position it to survive long enough to pass through the growth stages and grow as intended. Actionable data—Key Performance Indicators— are waiting for you in those financial statements and the numbers will show you how to best manage your entity.

Math might not be your strength but little by little, you can learn to recognize and interpret the numbers and allow your KPIs to do their job and function as guard rails that will make you an astute decision-maker. Running a business is all about making informed decisions that help your business operate efficiently and grow successfully. Just as your primary care physician monitors numeric values associated with certain of your bodily functions—-vital signs, your personal KPIs—-you do the same for your business.

Because 70% of businesses will fail after 10 years and you don’t want it to happen to you, let that scary thought motivate you to keep both hands on the wheel and manage your business wisely. There are many factors to evaluate, including your client list and the sales of your products and/ or services, but today’s focus is the financial management that your monthly or quarterly bookkeeping statements allow you to do. BTW, those statements also make preparing your quarterly and annual tax forms are more efficient and less stressful process.

Basic 3 financial statements

  • Income (P & L) statement. The income statement, also known as the profit & loss statement, is also known as the profit-and-loss statement. It sums up the money you collected from operations plus any other gains, as well as the money spent over a specific period of time. The basic formula is: Net Income = (Total Revenue + Gains) – (Total Expenses + Losses). You want your net income to be positive.
  • Cash-flow statement. The cash flow statement shows whether your business can pay its bills. This will give you a sense of where your business’ cash will come from and where it will be spent. Here you can also see customers that may “slow pay” to decide if they are putting your cash position in jeopardy.
  • Balance sheet. Your balance sheet summarizes your company’s assets, liabilities, and owner’s equity (or investment in the business), providing a snapshot of the financial health of the business at a point in time.

Trend analysis

Looking for trends can help you determine which products or services to promote, keep in stock, or stop selling altogether. Certain of your products or services may sell more frequently during some seasons and less frequently during other times of the year. Special promotions, perhaps advertised by way of email marketing and social media, is just one smart decision that examining sales trends can lead you to make. Another smart decision you might make is to initiate a demand pricing strategy and increase the prices of popular products or services during the time of year that they sell the most.

Get an unfiltered look at what clients prefer to buy on the top line of your P&L, Gross Sales Revenue. While many obsess over the bottom line, because it shows the total revenue earned (or lost) for the month, quarter, or year, the top line should not be ignored. When the top line shows healthy sales, it’s obvious that you’re doing something right. After that, it’s a matter of controlling expenses. Keep an eye on the trends in top line sales data, it is instructive.

Analyze and interpret

Also monitor your expenses, fixed and variable. Fixed (operating) expenses include office rent, W2 payroll wages and utilities. Variable expenses are often sales related, such as marketing and professional development. Increasing expenses may mean that you’ll have to alter some other part of your business (for instance, increasing prices when expenses grow). If certain clients are making late payments , potentially causing you to make late payments to your creditors, consider requiring late or slow payers to make a deposit of at 25% or so on the project you’ll do and/ or increase your project fee for late paying clients.

As you become more proficient in your understanding of financial data and interpretation, you can also calculate and follow certain financial ratios that can provide guidance. On your Balance Sheet you can calculate Net Working Capital, which is your current assets less your current liabilities. This is the amount of money you can use to operate the business day-to-day and invest in growth.

The Current Ratio equals current assets divided by current liabilities. In general, a ratio of one (1) or less indicates that there is not enough available capital to pay your expenses, which is a real problem. If your Debt-to-Equity Ratio (total liabilities divided by total assets) is greater than one (1), it is understood that the business is carrying too much debt—literally at a dollar to dollar ratio. Credit card debt and perhaps also other borrowing as a means to grow your business or pay expenses is bound to cause lending institutions to see your company as a credit risk. Direct your resources to paying down debt.

Bookkeeping software

If you have few transactions in a typical month, you may prefer to record client financial activity in Excel and send invoices in PDF format. If you have several client bills/ month you may prefer to install bookkeeping software. Freelancers and small business owners tend to work with small business specific, cloud, industry specific, or open source software.

Bookkeeping/ accounting software usually fulfills several functions in addition to generating the basic financial statements on a monthly or quarterly basis. You’ll also receive a collection of services that may also include invoicing, inventory management, payroll, financial reports and customer relations management features such as tracking client interactions, sales history and maintaining contact info. To compare features and monthly costs of several software services, click https://www.business.org/finance/accounting/best-bookkeeping-software/

Thanks for reading,

Kim

Image: This photo is from an album Elstner Hilton compiled in Japan between 1914 and 1918.

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Getting Started With Financial Projections

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Whether you are starting a new business, expanding or scaling an existing venture, or searching for investors, creating realistic financial projections is a vital component of the process. You’ll rely on those projections to make informed decisions as you execute the plans for your business. It’s imperative that you have a very good idea of the amount of money you’ll need to move forward with your intentions and how much money you can expect to earn as a result—-and also about when the expected revenues will arrive.

So, what is involved and where can you begin when your goal is to create financial projections for your business? The answer is—- surprise!—-do some homework first. Below are factors to research and help yourself create financial projections that help define the path to success that will work for your organization.

Your financial projections will be detailed in the basic financial documents—the Profit & Loss (Income) Statement, the Balance Sheet and the Cash-flow Statement. The Break-Even Statement will help you predict how much revenue the venture must generate to break even in terms of revenues versus expenses and when that’s likely to occur.

Something to keep in mind when you contemplate the need for financial projections is the distinction between projecting versus budgeting. Think of financial projections as a prediction, and budgeting as your plan. When you do a financial projection, you see what direction your business is headed in, based on past performance and other factors and use that to anticipate the future.

When you create a budget, you plan how you’re going to spend money based on what you expect your finances to look like in the future (your projections).

How big is your target market?

Start-up costs

This is the beginning in terms of your research and big question to answer. Understanding how to build a profitable business starts with determining the size and revenue (sales) potential of your market; if there aren’t enough buyers available, you’ll be unable to succeed. Most industry associations publish research regarding the size of their industry. Identifying three or four close competitors is also useful. Competition is a good sign, confirming that there is money to be made. You need to understand the annual sales volume expectations of your venture.

Expenses are much easier to predict than revenues. Start building your forecast model by outlining your fixed expenses, meaning rent, utilities and insurance. Next, consider the variable expenses, such as salaries, cost of goods sold (or the estimated value of the time it takes you to produce the service you offer). Business permits, required certifications and a marketing budget, for example, are other variable expenses to account for.

Also factor into your start-up costs your best estimate of site buildout and/or necessary equipment—coffee making machines, cash registers, computers, printers, online booking software, online payment or mobile payment plan, desks and chairs—in your financial projections.

Revenue projection

Thinking about how much revenue the venture will be able to generate, i.e., creating a sales forecast, attempts to predict what your monthly sales will be for up to 18 months after launching your business. Start-ups can make their predictions using industry trends, market analysis demonstrating the population of potential customers and consumer trends.

A pricing strategy is an integral component of a revenue projection. Research average industry pricing to ensure your prices are reasonable. Start by identifying the top players in your market. Then visit their locations or websites to determine how they price their products and services.

Cash-flow

A cash flow statement (or projection, for a new business) shows the flow of dollars moving in and out of the business. This is based on the sales forecast, your balance sheet and other assumptions you’ve used to create your expenses projection. If you are starting a new business and do not have these historical financial statements, you start by projecting a cash-flow statement broken down into 12 months.

Identify your assumptions

Any forecast requires you to make assumptions about possibilities that are outside of your control. The best way to manage these assumptions and avoid subconscious bias is by explicitly identifying and documenting them in writing.

The assumptions you should list include how much the market will grow or shrink, based on your research about the industry and local or national economy, changes in the number or activity of your principle competitors and/or technological advancements that will impact your business.

Break-even point

Together, your expenses budget and sales forecast paints a picture of your profitability. Your break-even projection is the date at which you believe your business will become profitable — when more money is earned than spent. Very few businesses are profitable in their first year. Most businesses take two to three years to become profitable. The Break-Even Statement will help you consider and plan for how long and how much revenue the venture must generate to break even in terms of revenues versus expenses and position the business for profitability. In other words, you’ll map out the scenario of pulling the business out of the red and into the black.

Thanks for reading,

Kim