Understanding Your Profit and Loss Statement

  • July 3, 2023
  • 3 min read

As a business owner, you regularly encounter various expenses presented to you by advertisers, marketers, and tech companies. While these opportunities may promise increased profitability, it’s important to scrutinize your profit and loss statement (P&L) before considering any new expenses or costs.

Start by meticulously reviewing each line item on your P&L and breaking them down into individualized bills. The objective is to identify whether each expense is categorized as a business expense or a cost of doing business. Understanding the difference between the two is crucial.

A business expense:

simply refers to an expenditure that incurs a monetary cost without providing a direct benefit to your business. It is essential to question the necessity of such expenses and evaluate whether they can be reduced or eliminated. On the other hand, costs of doing business are essential expenses required to support your operations and enable your business to generate revenue. For instance, if you have employees who directly contribute to serving your customers, their wages are considered a cost of doing business. Although they involve expenditure, they ultimately help your business generate more revenue.

Let’s consider the example of a salesperson who costs $10,000 per month. If that salesperson is responsible for bringing in $100,000 in monthly revenue, their cost is not merely an expense but a necessary investment or cost of doing business. In this scenario, it’s essential to distinguish between expenses that only consume resources and costs that contribute directly to revenue generation.

To further illustrate this distinction, let’s explore a real-life example:

A few years ago, our company was engaged in advertising through a specific channel. During a two to three-week period when some employees were transitioning to new roles, we decided to slow down order fulfillment to allow for a learning curve. To achieve this, we contemplated reducing advertising efforts for that specific period. While most of our advertising couldn’t be immediately halted, we discovered that a particular area of advertising, which we operated on a day-to-day or week-to-week basis, could be paused. This pause did not negatively impact our business; in fact, it simplified our message and led to increased sales. We realized that the paused advertising was not a cost of doing business. Rather a business expense that could be eliminated.

This categorization exercise can also be applied when dealing with salespeople who are trying to sell you something. Often, they will ask about your budget and attempt to lock you into a specific spending amount. In response, you can state that you don’t have a fixed budget. Instead, you evaluate expenses based on their potential to generate revenue. If an investment has the potential to make you money, you are willing to spend whatever amount is necessary to achieve higher returns. Conversely, if an expense has no potential to generate revenue or yields no return on investment, you cannot afford it.

By differentiating between business expenses and costs of doing business, you gain a strategic advantage when assessing each expenditure. Regularly reviewing your checking account and payment history can help identify unnecessary expenses that can be eliminated. Subscriptions for apps or running ads that yield minimal results can be canceled. Redirecting those funds to more productive avenues is a great example.

Remember, evaluating your business expenses and the costs of doing business is more than a semantic exercise. It allows you to make informed decisions, optimize your financial resources, and maximize profitability. Understanding the impact of each line item on your P&L; you can allocate your funds wisely.

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