Far too often I come across profit and loss statements (P&L) — and I’ve seen thousands of them — where the owner can’t tell me what would happen if one of the numbers changed. That’s not good.

Your P&L numbers need to be actionable. What do I mean by “actionable”? I mean that if a number changes, you know exactly what to do about it — and you do it.

Otherwise, to quote an old Neil Young song, the “numbers add up to nothing.”

If a KPI doesn’t cause any change in behavior (aka, an action), then it’s not really a KPI. It’s just an empty number.

Connect Income and COGS

You already have plenty of income accounts that you track. Keep tracking them. But in a world where we’re now delivering a lot of services, don’t just roll those new income streams into existing categories. Break them out, and itemize them on their own.

Why?

Because each income account has a corresponding cost. By breaking out your income accounts individually, you can match them to their associated costs.

Adding lines for studio rentals, platform usage, and content creation will allow you to track both the income and costs for those accounts. Some costs will be shared across accounts, and that’s fine. So, if you have 12 income accounts, you’d better have at least 12 cost of goods sold (COGS) lines to mirror those accounts.

And then you can take action on the numbers.

You’ll be able to see whether you need to adjust your pricing or margins for a particular service. Or maybe you need to get costs down, or get better at buying. Perhaps you need to purchase a piece of equipment instead of continuing to rent it.

You may even discover a need to hire. I usually advise against hiring, but sometimes you do have to make new hires. The numbers will tell you when.

Most of you are already familiar with the gross profit line, but do you understand what it means? To get the most out of it, categorize Income and COGS as intentionally as possible. This will allow you to see how everything connects and quickly understand what’s going on in your business

Keep Overhead Boring

Overhead, at least in theory, never changes — it’s dull and it’s boring. But in looking at trailing 12-month periods, which means you’re always looking at an entire year, you can monitor overhead ratios relative to revenue. You can then see how much you would be spending even if you made no sales at all.

You can break overhead down into three categories:

• Cost of Sales
• Cost of Administration
• Cost of Financing

Cost of Sales: This includes salespeople, commissions, marketing, and sales support. In some cases, half of your project management team is involved in selling the job and are therefore included in this bucket.

Before the pandemic, you might have been spending 8–12% of revenue on sales. If you’re now doing more agency and service work and less rental plus labor, the cost of sales goes up dramatically, to as much as 20–25% of revenue. This is because one sales unit in the new model can generate so much more potential income at a much higher profit margin. It makes sense to invest more in sales today.

Cost of Administration: This category is pretty self-explanatory. How much does it cost you to administer your business? The biggest cost here is executive team, so it’s best to have one account for senior management and another for accounting and office support.

Cost of Financing: This includes interest expense, depreciation, taxes, and other items associated with banking, leasing, and moving money around. Separating these expenses will help you calculate EBITDA (earnings before interest, taxes, depreciation, and amortization), which is frequently used in the valuation of businesses.

Together, all this will get you to a Net Profit from Operations (NPFO).

Net Profit from Operations

NPFO is where you can measure how well your management team is doing. Is your management getting you the operating profit you need?

Technically, the NPFO results from business activity, but not all income and expenses are part of business operations. There are some non-operating income and expense items that belong below the NPFO line.

For instance, adjustments include things like the PPP Loans of 2020–2021 for businesses in the U.S. As these loans were forgiven, they converted to income, but they’re not included in the income above because they didn’t come from any of your operations. They’re included below the NPFO line in non-operating income.

Even if you had negative net profit from operations, you would still add the PPP loan under non-operating income. You always want to see your business results with subsidies removed. Managing your P&L for business is not the same as calculating your income taxes.

Once the adjustments are made, you will have your Adjusted Net Profit, which is what you will be taxed on.

Take Action

Many of these concepts will be familiar to owners. The idea is to give you a cleaner, easier to way to identify the stakeholders at each step along the way.

You now have sales accounting for income, operations accounting for COGS, and management mitigating overhead and delivering a net profit from operations.

If something isn’t working, you know where to go to make adjustments. In other words, your numbers add up to something you can take action on.