The Alliance of Women in Workers’ Compensation hosted an event in Huntington Beach, CA focused on helping attendees gain understanding of business financial acumen. The event was held the day before the Executives in Workers’ Compensation Conference.
The session focused on helping attendees gain an understanding profit & loss statements (P&L) and and other business financial terms.
PROFIT AND LOSS STATEMENT
A P&L ( profit and loss) statement is also known as the income statement, statement of operations, or statement of earnings. The four main components of a P&L are:
- Revenues (also known as the top line) – the billed amounts for goods or services delivered during the income statement period;
- Direct Cost of Revenues – the direct costs of producing, purchasing or delivering the goods or services sold;
- Selling, general and administrative expenses – all the other costs it takes to run your business (for example, rent, insurance, marketing, travel, supplies, etc.);
- Net Income (also known as the bottom line) – the remaining profit or loss of the company after all costs have been deducted.
A P&L can be for any period of time (month, quarter, year), and can be for a division, company or consolidated group of entities. The audience for the P&L includes Owners, CEOs, Executives, Managers, Investors, Creditors, Government Entities, etc.
Gross profit is calculated as revenue billed (not necessarily collected) during the period for products delivered less the direct costs to deliver those revenues. Salaries for employees directly involved in the delivering the service or producing the goods being sold would be considered a direct cost of revenues. The costs of materials to produce products would be considered direct costs. Gross profit is a key metric to understand the health of the business model. If your gross profits are zero, it’s not worth continuing the business.
Gross profit is similar to your net paycheck in that your gross pay net of your taxes and deductions is what you have available to pay your mortgage, insurance, credit card bills, etc. Gross profit is what the company has available to pay all the costs of running the business. If your taxes or deductions increase you will have less available to pay for your fixed costs. This is the same with gross profit, which should be able to cover all selling, general and administrative expenses with some left over.
The gross profit margin is calculated as gross profit/revenues. Gross margin can be calculated and used to monitor performance year over year. There are typically industry standards for profit margins that can help you compare yourself to your competitors.
EBITDA is Earnings Before Interest, Taxes, Depreciation and Amortization. This metric measures performance without having to factor in: Financing decisions (interest expense); Accounting decisions (depreciation and amortization); Tax structures (tax rates vary by company). EBITDA can be used to compare companies against each other and industry averages. EBITDA is a good measure of core profit trends because it eliminates some of the extraneous factors and allows an “apples to apples” comparison.
Some do not like EBITDA as a financial metric since they feel it can be manipulated by companies that capitalize a large portion of their costs. These proponents prefer “EBIT” – Earnings before interest and taxes since it doesn’t exclude depreciation and amortization.
EBITDA = Earnings + Interest + Taxes + Depreciation + Amortization
EBIT = Earnings + Interest + Taxes
CALCULATING VALUE AND RETURNS
A commonly used metric is return on sales which calculates how much profit the company is producing per dollar of sales. Return on Sales = Net Income before Taxes/Sales
Another common metric is “Days Sales Outstanding (DSOs)”, which is the measure of the average number of days it takes a company to collect payment. Days Sales Outstanding = Accounts Receivable/Sales during the period x Number of days in the period. Typically this metric should be 30 days or less. If you are not able to collect your receivables in a timely manner you may be required to put up an allowance for doubtful accounts which can negatively impact your profit.
For publicly held companies two common metrics are Earnings per Share and Price to Earnings ratio. Earnings per Share is calculated as Net Income/Shares Outstanding. Price to Earnings ratio is calculated as Market Value per Share/EPS. A P/E ratio of 20 would mean that investors would pay $20per share for every $1 of earnings per share.
RETURN ON INVESTMENT (ROI)
Return on Investments (ROI) is the “what’s in it” for the investment you make. ROI is used as a tool for trade off decisions by management. It measures the efficiency of the investment. ROI = % Gain (Gain from investment- Cost of Investment)/Investment.
Example: Increase in advertising expense of $8m over 2 years resulted in $110m in additional revenue that contributed an additional profit (Gain) of $16m ($16m-$8m)/$8m = 100% return. Questions to ask: If I invested $8m elsewhere in the business, what would the return be? Which investment has the greatest return?
This shows what a company owns, and what it owes. It is a measure of the financial health of a company that is used by internal management to understand liquidity and investment opportunities, and by potential creditors and investors to understand financial risks. It consists of three components, Assets, Liabilities and Stockholders’ Equity. In order for a Balance sheet to be in balance, your Assets must equal the total of your Liabilities plus Stockholder Equity.
Assets are broken out into current and long-term buckets. Current assets includes cash on hand, short term investments, accounts receivables, prepaid insurance and prepaid expenses. These are items that are meant to convert to cash or be consumed within one year. Long-term assets includes your Capital Assets and other long-term investments that are meant to benefit the company for a period longer than one year. Liabilities include current liabilities (due within year) and long term liabilities (longer than a year).
Stockholder’s equity represents the assets available to shareholders after liabilities have been paid off (Assets minus Liabilities equals Stockholders’ Equity). Items included in this section of the balance sheet are Common and Preferred share, Additional Paid in Capital, and Retained Earnings, which is the sum of all profits earned by the company to date.
A capital asset is a type of asset that has a useful life that is longer than a year, and it is not intended to be sold in the normal course of business. Capital assets are reported as long-term assets on your balance sheet. Tangible assets are things you can see and touch like vehicles, machines, buildings. Intangible assets are thing like domain names, client lists, and intellectual property.