Most small businessmen do not prepare, read, understand or analyze their profit & loss accounts. They think this document is required mainly by big companies and is not necessary for small businesses. As a business grows year-on-year, the issue for most businessmen is, how can one determine their income-tax obligations? How can one avail of loans from bankers? And finally, the most important concern is how to forecast their revenue and expenses while setting yearly targets?
The profit & loss account provides information about an enterprise’s income and expenses which result in net profit or a net loss. It helps a businessman to evaluate the performance of an enterprise and provides a basis for forecasting future performance. It also provides valuable information required by a banker while sanctioning a loan.
The Profit & Loss account describes different business activities such as revenues and expenses, particularly useful in assessing the risk of not achieving a certain level of income in the future. It also provides information required to determine tax obligations.
“A profit & loss account is not only the statement of income and expense, but it also enables you to increase your earnings by reducing unnecessary expenses and increasing incomes,” states Garg Sharma Tandon & Associates, partner Sanjeev Tandon, a practicing chartered accountant since 1995.
Setting and achieving targets is the bedrock for the growth of SMEs and setting a target requires the projection of revenues and expenses. An established SME can make projections for its future revenue based on its past sales and expected income using its Profit & Loss account. As a small business starts and grows, it may find that its expenses increase at a higher rate. The SMEs may make accurate expense projections to avoid unnecessary expenses.
Analyzing a profit and loss account :
The profit & loss account of an enterprise can be analyzed by understanding its basic components.
Gross profit: This is the profit from the sale of goods that will be utilized to pay the operating expenses of the enterprises.
Higher gross profits mean that the enterprise will have more money to pay operating expenses like salaries, rent, and administrative expenses.
Indirect expenses: All expenses other than direct expenses are assumed as indirect expenses. For example, rent and taxes, salaries and wages, interest, depreciation, agent commission, advertisement, etc. These expenses describe the selling and administration cost of a business.
Net profit/loss: A profit & loss account has two sides, that is, the income part (credit side) or the expenditure part (debit side). The difference in the two sides of this account will represent either net profit or a net loss. A higher net profit indicates that the enterprise is more effective in converting its revenues into actual profit.
Gross turnover/sales: The gross turnover describes the total sales or gross receipts made during the year. Basically, it provides information about the size and value of the business. A comparison can be made between the previous year’s turnover and the current year’s turnover to analyze the growth of the business.