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Understanding Profit & Loss: Identifying Margins

By: Sam Harrington-Lowe - Updated: 28 Jun 2010 | comments*Discuss
 
Understanding Profit & Loss: Identifying Margins

The most important financial aspect of a business is profit. You could be turning over millions, but if your profit margins are low, it makes no difference if your turnover is ten thousand, or ten million. Equally, your loss margin works the same way. If you have a business that turns over a high sum, but you’re operating at a loss, no amount of money coming into the business is going to change the fact that you’re losing it!

It’s vital to know about your profit and loss to keep track of which parts of the business are more profitable, which parts cost the most money, and therefore how you can make changes to facilitate more profitable business.

What is Profit?

A business will have customers, and charge those customers money to provide products or services. Profit is basically the bit of money left over, once you have taken out all your outgoings and overheads including staff, premises, equipment, telephone, stationery etc. All businesses should operate a P&L (Profit and Loss) account so that it’s easy to see if the business is operating profitably or not, and keeping it up to date is good business practice. Inputting financial movements is a sound habit to cultivate and will help to ensure you know where your business is going.

How to Run a P&L Account

There are many software packages that can make this easy for you, but it’s also equally easy to do it using simple programs such as Excel spreadsheets. Your accountant will be able to help you identify your overheads (fixed costs) and expenditure, and of course you will easily be able to keep track of your invoicing i.e. the money coming in! Look also at other sources of income such as rent from tenants etc, and once this is in place, the best thing to do is to try and keep it fairly up to date.

Assets and Liabilities

Running a P&L account as described above is putting it in its simplest terms, but there are more aspects to consider, such as current or fixed assets and liabilities. These also all affect your P&L sheet as they identify areas where potential money could be made or lost.

Assets fall into two, or possibly three categories. Fixed assets are things you own and keep, rather than selling to customers. In the events industry for example these could be props, but equally, as with all businesses, will include premises if you own them, furniture, vehicles etc. Current assets is basically potential revenue you can get your hands on quickly, such as unpaid invoices, cash in the till, stock, outstanding expenses etc. Finally there is such a thing as ‘intangible assets’ which covers slightly more nebulous assets such as goodwill – i.e. a great client list that could potentially bring in revenue – and revenue from things like copyrights or patents you might own.

Liabilities of course are exactly what they say they are. Liabilities can be bank loans, suppliers’ invoices or VAT bills. It’s all money pending going out.

Provision for Bad Debt

Look out for this one and always factor this in, rather than get caught on the hop. In your current assets you might have money that is due in to you from customers. Assuming you are confident they will pay you, there is no problem and they should be added to your current assets, but if you think there may be a problem extracting the money, or perhaps part of the money, you need to have another column ‘bad debt provision’.

Depreciation

Finally understand the relevance and importance of depreciation. For example, an item may have cost you £5,000 to purchase, but after a couple of years it won’t be worth so much. This is technically a loss as you are losing the money you spent on it and depreciation should be accounted for along with everything else.

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