Creating income and expense codes to setup a useful P&L for your business sounds about as exciting as sweeping the floors in your shop… Better left to your accountant, right? Wrong! Unless your accountant is quite business-savvy that’s a mistake because accountants aren’t necessarily trained in business… They’re trained in accounting… And there’s a big difference between the 2.
If your accountant did setup your GL codes now’s a good time to review them to see if they’re providing you valuable information at a glance. Here are a few quick rules to setup a useful, valuable Profit & Loss statement that will actually provide you with the information you need to make important business decisions. First of all, let’s lay out the goal for your P&L. The goal of a small business P&L is to quickly show you which departments (or revenue streams) in your business are making money and which are not. The secondary goal, for when you go to sell your business, is to provide you with a cashflow value of the business utilizing EBIDTA or Seller’s Discretionary Earnings. The third use of your P&L is of course taxes. For this article, let’s focus on your month-to-month use of a profit and loss statement, not just it’s utility at the time of sale or for paying your tax bill.
- Income and expense codes should be departmentalized. – This is crucial because it’s the only way for us to tell where the money is coming from and where the money is going. As an example if you own a powersports dealership, you should have separate income codes for motorcycle sales, ATV sales, jet-ski sales, dirt-bike sales, motorcycle parts, ATV parts, jet-ski parts, dirt-bike parts, and service. Breaking out service according to each isn’t really necessary since your labor costs are generally the same regardless of whether you’re working on a jet-ski or motorcycle. Though it’s not necessary on your P&L, you should also be able to tell which type of bikes are selling best and with the best margins and which are not (i.e. cruisers vs sport-bikes, Harley vs Can-am).
- Income codes should have a matching expense code. – From the example above each of those income codes should have a corresponding expense code such as Cost – Motorcycles, Cost – ATV’s, Cost – motorcycle parts and so on. Why? Because that’s what tells us quickly if each of our items are priced at a profit (or not). This is actually a rather common problem in small businesses. Costs go up over time and owner’s don’t increase sale prices to match because they aren’t ordering or reviewing each statement so they just don’t notice. When your P&L does that work for you, it’s easy every month to review and catch any drastic changes in margins. Granted, to really keep on top of your margins for everything you sell, a detailed parts and equipment list that is CONSTANTLY updated is vital.
- Cost of Goods Sold codes should only be codes that are affected by fluctuations in sales.– This is just a rule of thumb for determining if an expense should be COGS or an Operating Expense. If sales going up or down doesn’t change the expense in question, it should be considered an Operating Expense.
- Wages should be departmentalized (and segregated between COGS and Operating Expenses). – Sales commissions and service department wages are a Cost of Goods Sold. Office staff, accounting, customer service, and managers (outside of sales and service managers) are an overhead and should go in your Operating Expenses along with the corresponding payroll taxes and benefits.
- Insurance should be broken-down. – By this I simply mean just because you get a single bill from your commercial service provider for General Liability, Vehicles, Buildings, and Inventory you shouldn’t just put in a single line-item on your P&L for Insurance. Each of those items should be listed individually under your Operating Expenses.
- Royalties are a COGS. – In most franchises royalties are levied as a percentage of revenue and should be listed as a Cost of Goods Sold, not an Operating Expense. Additionally, royalties should be considered a marketing expense since, in exchange for paying those royalties, you get to use your franchiser’s name and the goodwill and value they’ve invested in that name.
That’s it. Making an effective P&L for your business can be done in an afternoon and once setup in your billing and accounting software should easily provide you with the vital information you need for years with very little ongoing maintenance. Take the time to update your P&L and start making better business decisions today.
To your accounting success, Bryan