What is a profit and loss budget?
Before we discuss P&L budgeting, it helps to know what a P&L statement is.
A Profit & Loss (P&L) statement is a financial report that shows how much your business earns and spends within a specific budget period.
P&L statements show the total revenue (income before business expenses) a business has earned and all the expenses related to generating that revenue - such as cost of goods sold (COGS), wages, taxes, and other operational costs on a profit and loss basis.
By tracking income and expenses over time, you can develop an accurate picture of your cash flow situation. This allows you to analyze trends and make better business decisions.
A P&L budget, therefore, is a planning tool used to determine a business's expected income and expenses over time.
It serves as a guide to cost reductions, strategic plans, profit-building, and more.
Profit and loss budgets help organizations identify how to stay ahead and manage resources. It also gives leadership an estimate of how much money the company can expect to make each month, quarter, or year based on how you estimate income and expenses.
This budgeting may occur on a monthly, quarterly, or annual interval.
More advanced FP&A teams will use pro forma P&L statements in their cash flow forecasts.
What are the elements of a profit and loss statement?
A P&L is a simple but important document for keeping track of the financial health of your business.
For a quick look at your numbers, you can use the formula to calculate profit and loss:
Revenue - Expenses = Profit/Loss
When you want a more detailed view of your business, use a P&L statement:
There are two ways to build a profit and loss statement: Single step, or multi-step.
Single-step P&L statements provide a quick glance at your numbers. It lists all the income and expenses in one place.
While this helps you take a quick temperature of the business, you can get more detail by using a multi-step P&L statement showing net income and expenses over a specific period.
Use multi-step P&L statements if your company has multiple income streams or operating costs (for instance, if you have investments instead of just sales revenue).
In multi-step statements, expenses are broken down into operating and non-operating costs.
Operating costs show income and expenses from operations activities like fixed assets, marketing, salaries, and COGS.
Non-operating costs show costs and expenses incurred for things like investment gains and losses.
What are the key elements of profit and loss statements?
Regardless of the type of P&L statement you create, a well-structured P&L will feature several key figures:
Revenue: Cash earned from the same of your products or services.
COGS: The cost of supplies, components, and production for your products or services.
Gross Profit: The profit made before you subtract COGS from revenue.
Net Profit: The money made after subtracting your total expenses from revenue.
Operating Expenses: Costs associated with direct operations for the business.
Overhead expenses: Indirect costs like administrative fees, general expenses, and sales costs.
Tax: This is the amount you pay for local, state, and federal government on the income you make from the business.
What’s the difference between a P&L budget and a cash flow forecast?
A P&L budget is a statement that summarizes the expected revenue, income, and expenses for a specific period of time. It tracks your past business activities and the actual results of those actions. It helps you compare those actual results to planned objectives. It can be used to estimate how much profit or less the business will sustain over a given financial period.
A cash flow forecast, on the other hand, is a document that outlines how much cash you expect to receive and spend during a specific period of time. This type of forecast helps track incoming revenue, outgoing expenses, and changes in cash position over time.
While both documents are important tools for forecasting financial performance, the P&L budget is useful for understanding the company's overall profitability, while the cash flow forecast is more focused on tracking cash transactions.
5 top benefits of a P&L budget
Everyone works better if they have a plan. A P&L budget offers various benefits for every level of the organization:
1. Increases spend efficiency
Budgeting for profit and loss enables companies to plan and execute finances with stability.
By understanding how much money goes in (inflows) and goes out (outflows), businesses have a better idea of their financial standing and are poised to make informed decisions about spending.
For businesses aspiring to grow, implementing profit and loss budgeting is key to identifying trends and areas of improvement in their operations.
2. Enables cost control
Budgeting is critical to managing an organization's financial resources effectively.
Setting out forecasted expenses and revenues allows Finance to identify potential areas for cost reduction and operational efficiency.
Through careful monitoring of expenses and comparison against the budget, businesses can optimize their use of available resources and make strategic decisions to improve their bottom line.
3. Sets departmental expectations
Proper budgeting gives every department leader and buyer a clear understanding of how much money they have on a monthly, quarterly, or yearly basis.
This allows them to prioritize expenses and allocate funds where they will be most effective, leading to more efficient use of company resources.
4. Informs forecasting efforts
A strong P&L budget helps Finance forecast the expected revenues and profit for the upcoming reporting period.
This helps them make investments, plan capital expenditures, make hiring and wage decisions, and inform the executive team on mid to long-term strategy.
5. Demonstrates creditworthiness
A P&L budget gives lenders and investors key insights into a company's creditworthiness. It gives them an understanding of the company's current financial position and its prospects for future growth.
For example, lenders and investors can use a P&L budget to determine how much money the company can repay its creditors if it takes on debt.
They can also evaluate the organization’s spending habits and potential future returns of those investments.
By looking at a company's P&L budget, lenders and investors can make informed decisions about investing in the business.
What are the steps for creating a P&L statement?
Ready to get a better handle on your profit numbers? Follow these steps to build a profit and loss budget.
1. Review your business plan
The first step in building a P&L budget is to examine your business plan and currently established goals.
(See the section below for a step-by-step guide if you don’t have a business plan).
Your plan should have SMART goals (something like “grow your active customer base by 5%” or” increase average order value or AOV by $10”).
Once you’ve defined these goals, they can be built into the budget.
2. Select a budgeting methodology
Choosing a budget methodology helps you decide your approach when creating your P&L budget.
Here are some examples:
Incremental budgeting involves using existing numbers as a base for the new budget.
Activity-based budgeting looks at expenses related to activities and spending patterns within the business.
Zero-based budgeting requires justification for each item in the expenses list.
3. Track your revenue
Look back on the previous revenue period and track all income sources.
Add these to your P&L statement in your accounting software (or use our free template!)
4. Determine COGS
Organize all the expenses directly related to the production of your products. Include items such as:
- Materials costs
- Equipment costs or leasing
- Contingent staffing costs
Be sure to include any and all costs outside your daily operations required to produce what you sell.
5. Calculate overhead costs
Calculate overhead costs by listing all expenses unrelated to the production of goods. Include items such as:
- Employee salaries
- Office space
These monthly figures don’t change, regardless of production volume.
6. Estimate operating income
Deduct your overhead from gross profit to get your determined income from operations.
7. Adjust for other income (if you have it)
If your business receives or spends money through investment or financing—interest, dividends, loans, etc.—adjust these out of your operating income to calculate your net profit (also known as pre-tax income).
8. Calculate net profit
Your net profit is the most valuable number in the P&L calculations.
After all calculations, your net profit shows how much you bring into the business (or how much you lose if you’re not turning a profit).
Once you have a profit and loss statement, you can use it to inform your other financial reporting, including your income statement, balance sheet, and cash flow statements.
How to use your P&L info to create a P&L budget
Now that you’ve got a good grasp of your current financial situation, you can begin to budget for future periods.
A budget for P&L needs to consider costs, profits, and losses over a fixed period of time.
To create an effective budget, it is important to consider both expected and unexpected costs that may arise, such as the cost of resources, staff training, marketing expenses, etc., as well as any potential revenue from sales.
Setting aside funds for unexpected costs can help ensure the business doesn't suffer from financial issues should something unplanned occur.
Once these are accounted for in the budget, businesses can plan how best to use their available resources to reach their targets.
What if you don’t have a business plan (yet)?
A business plan is a detailed description of the company's current financials and its goals for the future.
It's used to assess the company's strengths and weaknesses, define its objectives, set measurable goals, and develop strategies to achieve them. It’s a key component of your P&L budgeting.
If you have a business plan in place already, take time to review it. If not, follow these steps to build a simple, effective business plan before you begin the budgeting process:
1. Write your executive summary and company description
The executive summary is a short document summarizing your business plan's details.
Think of it as aIt should include the purpose of your business, the financial goals you want to achieve, and any other key points.
This should be concise, informative, and an overview of what’s included in the plan.
The company description is a more detailed overview of your business, including its history and structure (sole proprietorship, partnership, or corporation).
Give a brief history of your company and its reason for formation.
2. Outline business goals
Put in writing what your short-term and long-term goals are for your business.
This will help you create a plan outlining how to meet those goals.
Additionally, by writing out your goals, it will be easier for investors or lenders to see where you plan on focusing resources and can better evaluate the viability of your enterprise.
3. Detail your product offering
Describe your product offer, briefly describing the product or service and how it solves customer problems.
Next, provide in-depth descriptions of each product and service with all relevant information included.
You can do this by comparing different products, listing features with their benefits, or providing technical specifications if necessary.
Include pricing information for later reference.
4. Conduct a market analysis
Market analysis is a key data component when building your business plan.
Conduct market research to learn potential customers' size, demographics, and location.
This data helps you determine the feasibility of a product or service, spot opportunities and trends, and inform pricing.
Consider compiling your data into charts and graphs to make your data more user-friendly. Use your market analysis to align marketing and financial projections.
5. Create a sales and marketing plan
Identify the strategies you’ll use to reach potential customers, such as developing campaigns on social media, launching advertising, creating partnerships with other organizations, or creating an email list.
Consider the target audience, budget constraints, and tactics to reach them when creating the plan.
Documenting these activities will help you create a sales budget to support them.
Conclusion: all about the P&L budget
Now you know all about how to make a P&L budget.
But have you heard about Cube?
Cube helps you monitor and track your profit and less with its native Excel integration and connections to your ERP and other source systems, like Salesforce.
The ability to manage scenarios within Cube means budgeting and budget variance analysis have never been easier.
And when you're done? Share your P&L budget with the executive team via Cube's Google Sheets integration.
Click the image below to schedule a free demo and learn more.