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hi there this is John are not welcome back to business mastery tonight we're going to talk about the P&L so stay tuned [Music] whether you're a solo enterprise or a major global organization there are certain financial aspects of your business that you must manage and monitor to be successful in this video we're going to discuss how a small services business manages its expenses and its revenue the primary report a business uses to manage is called the P&L or the profit and loss statement all accounting systems have this report but many times the insights associated with this report are lost in this video I'm going to teach you how to read the P&L but more importantly how to use the PNL as a way to measure the health and manage your business to health of course always like your feedback so if you like what you see I'd really appreciate a like or some comments and if you want to see more videos like this from me hit the subscribe button and if you want to be notified hit the bell in your services business how are you managing it are you managing it like a business are you managing it like you would manage a checking account many business owners often get started where they manage their business like it's a checking account they look at the balance and if there's enough cash they just assume everything's ok but that's not really how you must run a business even if it's just you by yourself or doing this part-time you need to manage your enterprise as if it was an enterprise and I hope to uncover how to do that in a very easy way in this video first what is it that we're monitoring we're going to start with four components at the very top that is the top-line well that's your revenue next are the costs associated with delivering the services that get you that revenue we call those cost of goods sold when you take the revenue and you subtract the cost of goods sold what do you get you get your gross profit the gross profit is what contributes to the operations of the business and ultimately to the distributions to the shareholders gross profit moves downward to expenses and these are the expenses used to operate the business when you take gross profit and you subscribe subtract the expenses then you get net income and net income is what serves your shareholders and is what is used to build your resources to build the cash on hand so let's think these things through you have your revenue cost of goods sold which gets gross profit subtract the expenses get your net income and that is the high-level view of the PNL now let's dive into some more detail when we think about how we're managing this P&L we think that maybe we should just manage it to the dollar amounts and that's how your typical P&L shows up it shows dollar amounts but that gets confusing from period to period if certain numbers are changing for example if your revenue is changing then the expenses associated with that revenue need to change correspondingly that's why what I recommend is to manage two percentages now if I want to look at this high-level view when I think about my top-line or my revenue my cost of goods sold in a services business needs to be fifty percent or less now different businesses vary but for the sake of this video let's say our gross profit needs to be fifty percent or more so revenue minus cost of goods sold should be fifty percent or less if I'm managing my gross profit to 50% and say I want to have a net income for the purposes of putting getting cash on hand extra resources and distributing to my shareholders of say 10% then I need to have no more than 40% in expenses so gross profit 50% expenses 40% which gives me a net income of 10% and I want to manage this way so as I dive in to my cost of goods sold I can break things down and manage a monitor different components so that I'm always at 50 percent or less of my revenue so for example in a sample services company I have a revenue of let's call it a million dollars and if I'm managing that to a gross profit of 50% that means that revenue of a million dollars I cannot have any more than $500,000 in cost of goods sold to yield $500,000 in gross profit so that 50% cost a good soul like what goes into that well there are several things that go into it the first thing that would go into it is the labor associated with delivering that service now that labor could come in two places that labor could be payroll that is w2 employees that are hired specifically to deliver those services it also could come in the form of contractors subcontractors that you bring in that are only there for the sole purposes of delivering those services and that labor component is in a services business a very large part of the cost of goods sold so in a services business we might find that we might be managing to 40 45 % potentially of revenue as our labor component but we're not managing to the full 50 percent because there are typically other things that go in to cost of goods sold there are sometimes there Commission's that go directly into it there might be soft our licenses that go into delivering the service there might be other pieces of hardware or software or other outside services that go into it the key here is that you want to break down each of the items that falls in the cost of goods sold and create a set of rules around what percentage that should be going forward so that if you're providing a service and 45% is labor well then know 5% more than 5% of that could be for software for example and so when we look at our example on the screen right now you'll see this example has different line items under under payroll under contractors which are different line items for different types of subcontractors you have some software in there but it all adds up to that 50% target so what happens as a manager is if you start seeing the P&L coming in either on a regular basis or at very worst monthly and it's showing that you're at fifty four percent fifty seven percent you have a problem because you are likely dipping directly into net income and that can cause a serious issue down the road so you want to make sure you manage to that another thing to look at is when you're looking at the balance between contract labor and payroll in the cost of goods sold you might find in a certain certain situation your payroll is high your payroll is a high percentage and maybe your your contract labor is still at its level that was planned if that's the case then the w2 employees on hand or on staff rather those people are likely underutilized or they're putting time into other areas outside of cost of goods sold where maybe their talents can be used inside it could cost of goods sold when you see things like that happening you should look for ways that you can reduce contract labor and assign it to the payroll the people on staff that are w2 employees so that you're not paying a subcontractor to do something that one of your w2 employees could do themselves this helps managing that piece of it so now that we have an idea of what it is that goes into cost of goods sold and we know what we're targeting for gross profit let's work our way further down let's look at expenses and expenses can be anything to operate the business this can be rent utilities expenses could be software licenses it could be paying for professional services accounting legal expenses go are the components of payroll like benefits they are marketing their information technology there are all the things that go into operating the business that aren't directly associated with delivering the service and that's what falls in your expenses bucket and this is an area that often can get away from a business because sometimes business leadership has a plan for growth and they see a vision where they want to go but they need resources they need infrastructure needs other pieces in place to get there and so what will happen is expenses may be incurred prematurely that caused that business to either lose profitability or go unprofitable so watching expenses in those line items is very important now what I would suggest you do is much like we talked about a cost of goods sold under expenses each expense category you need to make it manage to a percentage of revenue as well so let's go through some of those categories so you might have a category so you take credit cards for bank card processing fees you might have a category for benefits or a payroll category that includes benefits you'll definitely have a payroll category for payrolls that are not associated with people that are directly contributing to these services that are being delivered and cost of goods sold you're going to have your rent you're going to have your utilities all these different categories are going to have a budget associated with them and I encourage you to set that budget as a percentage that way at any given time you can see where things are changing and so if you find yourself in a situation where revenue is going up things might look really good but if you find yourself with revenues going down and the percentages are going up that's when you have to read consider some of those expenses some expensive may have made sense when you first incurred them but as things have changed and times have changed your revenue has changed it's time to revisit them if you're disciplined about these percentages then you have a way to know what it is that you need to cut or reduce to expenses I want to speak to now why don't talk to the marketing expense and the example I'm showing you here it's 7% and while marketing expense does vary by industry and by the cycle of a business for example marking expenses should be higher at the start of a business than they are when it's an ongoing concern or a rule of thumb you can look at this at about a 7% number in a services business 7% you can leave it there another expense I want to look at is a category that often ends up on your P&L called other expenses what happens is an expenses come in and they don't get categorized properly and they get dumped in this bucket called other expenses be really careful there because that's where things can get away from you I encourage you to manage other expenses to a percentage as well that way as these are coming in you know things are getting out of line but every period you should evaluate other expenses to determine if these items could fall into a better category either an existing category or come up with a whole new category for that expense type thereby always about evaluating and re-evaluating those things that are coming up that are not really pertinent to the business at least not pertinent not that they got their own category and the Bott last thing at the bottom well that's your net income and in this example we're targeting 10% some businesses target more some target less and what you should think about net income is that's not just money going into the pocket of the owners net income initially is used to build cash reserves cash reserves are really important you can never know when some economic downturn can I incur we happen to be in the middle of one right now as I create this video and there are many businesses that literally are operating so on the cash reserves they put in place so net income of 10% well if you're doing that every single month it's going to take six months to build up a six month Reserve so think of a net income as contributing to your cash reserves that you have in place for when things and cycles take a downturn this is also really helpful for businesses that are more seasonal businesses where their services spike during one period and then come down at others you know think about accounting services for example things go like this you want to make sure that you have the reserves in place to pay for the resources necessary to support the really really going times and also keep the resources in place when things get a little comma and then after that net income is what is distributed to the shareholders typically on an either a quarterly or annual basis so to reiterate what we've put together here think of the PNL as a simple tool to manage the health of the organization and break that PL down to the simplest components monitor that revenue keep a close eye on cost of goods sold make sure your gross profit is at or greater than a specific target percentage manage your expenses to be a percentage of that top-line revenue and then keep a good eye on net income to make sure that you are funding your cash reserves and putting the pieces in place to give a distribution to your shareholders I enjoyed giving this video to you I hope it was helpful again if you liked what you saw here click the like button if you had some questions or you you are managing to a whole different set of percentages give me a comment Flo I would love to hear what kind of percentages you manage to if you want to hear more videos like this click Subscribe and you want to be alert and hit the bell thanks again I look forward to talking to you on the next video