Updated: Apr 23, 2019
In Italy, they speak Italian. In Germany they speak German. In business we speak accounting, or more roundly numbers.
You see business is all about the numbers. It is an intellectual sport.
Now don’t be scared off by this because the numbers are nowhere near as scary as you may have been led to believe. You don’t need to be Einstein to play this game called business.
If you can do addition, subtraction and percentages you are more than qualified.
There are 3 scoreboards to let you know how you are playing the game.
Lets take a look at the 1st scoreboard of your business.
Scoreboard 1 – The Profit and Loss Statement
The profit and loss statement (also known as P&L or Income Statement) is representation of the past in your business. In short it is a summary of what came in, what went out and what was left. In other words, how you played the game for that period of time. It is also used to determine your taxes.
The format for any profit and loss statement any where in the world is the same and it looks like this, Income minus Cost of Goods Sold equals Gross Margin. Then Gross Margin minus Fixed Expenses equals Profit. Or laid on a P&L statement on paper it looks like this.
Cost of Sales
= Gross Profit –
= Operating Profit
It can get confusing sometimes as there are different names for the elements I have written above, so here is a quick decoding for you.
Income can also be known as Revenue or Sales or Turnover.
Cost of goods sold (COGS) can also be known as Cost of Sales and is sometimes called variable costs because this figure varies with sales. The way to determine if a cost should go here is if it is a cost incurred because we got a sale. For example the cost materials and or products that are sold (at a markup), subcontractor wages if you use them to deliver the product or service sold.
Gross profit can also be known as Gross Margin or contribution margin, because this contributes to running the business, that is the fixed expenses (see next). The gross margin is the total of all the little margins on all your sales.
Fixed expenses can also known as Operating Expenses or Overheads, you can think of it like the fuel to run your business engine. It is called fixed because you have to pay this expense even if you don’t get any sales, which is the opposite of variable expenses ie Cost of goods sold etc from above.
This leaves the operating profit at the bottom. You will sometimes see this referred to EBITDA which stands for Earnings Before Income Tax, Depreciation and Amortisation, essentially this means before you accountant gets to it.
Your net profit is after your accountant has got to your figures and made all the tax effective legal adjustments. You can remember this by thinking of a net at the bottom of your P&L which catches everything after it has passed through all the above parts.
Now there are 2 ways of accounting or keep or keeping the score.
Firstly there is cash accounting, which means basically that you don’t have accounts with your clients or suppliers and everything is done on an instant transfer of cash for a transaction.
Secondly there is accrual accounting, which means that you do have accounts with clients and suppliers, thus there is time between when you order or complete work and when you get paid. So you can accrue (add up) credits (creditors are people who give credit to us, ie we owe them) or debits (debtors are people who have a debt to us ie they owe us).
If you are a cash accounted business, the following blogs are not relevant for your business. But if you do have accounts for clients and with suppliers, make sure you read the next couple of blogs.
If you would like a copy of my financial mastery cheat sheet, email me email@example.com