Back to the on-screen lesson · Print

A simple profit and loss

Three lines and two subtractions: gross profit says whether what you sell is worth selling, operating profit says whether the business is ahead — and how stock left on the shelf changes the first.

Paper packet. Every task here also exists on screen, where it is checked automatically; answers written on paper are not assessed by Nydus. When you are back at a device, enter your answers there.

1. What you will learn

You will lay a month out as a profit and loss — revenue, the cost of what was sold, gross profit, the cost of being open, operating profit — work out the cost of what was sold from opening stock, purchases and closing stock, find the gross margin, and say which profit line answers which question. You will also read two months side by side and say which line a change points at.

2. What you already have

You can work out what one sale contributes, you keep a daily record of what came in and went out, and you keep the business's money apart from your own. A profit and loss is that record arranged for a month, so the month answers two questions rather than one: is what I sell worth selling, and is the business as a whole ahead?

3. Words this lesson uses

4. Three lines and two subtractions

A profit and loss is three counted lines and two subtractions, answering two questions owners constantly mistake for each other.

$$\text{gross profit} = \text{revenue} - \text{cost of what was sold}$$

Gross profit judges the unit. Is what I sell worth selling at the price I charge? Only the cost of the thing sold has come off. A thin line here is a pricing or buying problem, and cutting the rent will not fix it.

$$\text{operating profit} = \text{gross profit} - \text{cost of being open}$$

Operating profit judges the business. Is the whole enterprise ahead? The rent, the insurance and the advertising come off once, from the total, because they were spent on the month and not on any sale.

Read one and mean the other and the month is misread: a good gross margin with no operating profit sends an owner to raise prices, the one thing already working.

5. The method, step by step, and how to check it

Take revenue from the record. Add every sale in the month, paid or owed, at the prices charged. Leave out money the owner put in and deposits for work not yet done: neither is revenue.

Work out the cost of what was sold. For a maker or a reseller, this is the stock at the start of the month, plus what was bought during it, less the stock left at the end. For a service, it is the direct costs of the jobs done: materials used, subcontractors, per-job fees. Stock still on the shelf is not a cost of this month.

Subtract for gross profit, and find the gross margin. Gross profit over revenue, times 100.

List the cost of being open. Everything spent on the month rather than on a sale, from the categories in the record. Leave out drawings: they are the owner taking money out, not a cost.

Subtract for operating profit.

Three checks. The lines must add back: cost of what was sold, plus cost of being open, plus operating profit, equals revenue. Gross profit must be larger than operating profit unless the cost of being open is zero. And the gross margin should be close to last month's unless prices, buying costs or the mix changed; a sudden move with no reason is usually a stock count or a misplaced cost.

6. What belongs above the line and what belongs below it

The only judgment here is which side of the gross profit line a cost goes, and one question settles it: was this spent on the thing sold, or on the month? Clay in a mug that sold, a crate resold, a rider paid per delivery and the card fee all go above. Kiln rent, insurance, the phone and advertising go below.

Two traps. Stock that has not sold: a crate bought in March and sold in April is a cost of April, because the line is the cost of what was sold. And the owner's own pay can fall on either side of it, depending on whether it is costed per unit or taken as drawings — say which, and keep it the same every month.

7. Reading two months side by side

A single profit and loss says whether one month was good. Two or three side by side say what is changing, and the two margins tell you where to look.

The table is a starting point for a question, not an answer. A falling gross margin at Monica's stall might be dearer mangoes, more waste, or a shift toward her cheaper lines; the daily record tells her which. What the two margins do is stop her looking in the wrong place: no amount of work on the rent will fix a gross margin that fell because the wholesaler's prices rose.

8. How the statement connects to contribution and break-even

The profit and loss and the contribution arithmetic from the pricing unit look at the same month from two angles, and each can check the other.

Contribution splits costs by whether they move with volume: variable costs come off each sale, fixed costs come off the month once. The profit and loss splits costs by whether they were spent on the thing sold or on the month. The two splits are close but not identical. The card fee is variable and sits above the gross line in both. A kiln rented only for one product line is fixed, so contribution puts it with the month, while a careful profit and loss might treat it as part of that line's cost of what was sold.

Where the two splits agree, gross profit equals total contribution, and operating profit equals total contribution less the fixed costs — the same figure break-even is built on. That gives a useful check: if the month's operating profit and the contribution arithmetic disagree, one of the costs has been placed differently in each, and finding which one usually reveals something about the business worth knowing.

In practice, owners use the profit and loss to look back at a month that has happened, and contribution to look forward at a decision still to make. Both need the same records, kept with the same categories, which is why the daily habit of writing down what each cost was for matters so much. A record that says stock on one line and misc on the next can answer neither the backward question nor the forward one with any confidence.

9. In the world: a café's first quarter

A café lays out its first three months. January: revenue 14,200, cost of food and drink sold 4,540, gross profit 9,660 (68 percent); rent, wages, energy, insurance and software 10,300; operating loss 640. February: revenue 15,100, cost of what was sold 5,140, gross 9,960 (66 percent); overheads 10,200; operating loss 240. March: revenue 17,800, cost of what was sold 6,410, gross 11,390 (64 percent); overheads 10,400; operating profit 990.

Read side by side, the two margins tell two stories. Revenue is growing and the café moved into profit in March — good news carried by volume. But the gross margin has slipped four points in three months. At March's revenue, each point is about 180 dollars a month. The owner checks the daily record and finds two causes: the dairy supplier's prices rose in February, and more customers are buying the lower-margin lunch plates rather than coffee and cake.

Neither is fixed by trimming the rent or the wages. She renegotiates the milk and raises the lunch plates by 50 cents, and April's gross margin returns to 67 percent on similar revenue — worth over 500 dollars a month, which the operating profit line would not have shown her the cause of.

10. In the world: how companies report it

Listed companies publish the same statement in more detail — revenue, cost of sales, gross profit, operating expenses, operating profit, then interest and tax — and analysts watch the margins more closely than the totals, for the reason in this lesson: margins show where a change came from.

11. Where this goes wrong

Calling revenue profit. The biggest number on the page has had nothing taken off it; a record month can be a losing month.

Quoting gross profit as profit. Announcing the gross line as the month's profit overstates it by the whole of the rent.

Counting everything bought as the cost of what was sold. Only what sold goes there; stock on the shelf is not a cost of this month.

Putting drawings among the costs. They are the owner taking money out, and among the costs they make a working business look like a failing one.

Reading the statement as the bank balance. A month can show a profit and end with less in the account, because a sale on terms is revenue now and cash later.

Fixing the wrong line. A thin gross margin is a pricing problem; a thin operating profit under a healthy gross margin is an overhead problem.

Revenue up means the month was better. Read down to the bottom line first; a busier month with a thinner margin can leave less than a quiet one.

12. A month at Monica's Market Stall

1. Write the revenue.

   $\text{revenue} = 5000$

   Counted, not worked out.

2. Write the cost of the crates she sold.

   $\text{cost of sold} = 4000$

   Only the crates that left the stall.

3. Find the gross profit and margin.

   $5000 - 4000 = 1000; \quad 1000 \div 5000 = 20\%$

   The unit question, answered.

4. Take off the pitch fee, insurance and van.

   $1000 - 750 = 250$

   The operating profit.

5. Read both lines together.

   $20\% \text{ gross}; \ 5\% \text{ operating}$

   A thin gross margin means the whole business rests on volume.

13. A month with stock left on the shelf

1. Write Maya's stock at the start of the month, at cost.

   $\text{opening stock} = 600$

   Mugs already made and not sold.

2. Add the month's clay, glaze and boxes.

   $600 + 1400 = 2000$

   The stock available to sell.

3. Take off the stock left at the end.

   $2000 - 440 = 1560$

   The cost of what was sold.

4. Find the gross profit on revenue of 3000.

   $3000 - 1560 = 1440$

   Not 3000 − 1400: the purchases are not the cost of what was sold.

5. Take off the cost of being open.

   $1440 - 1200 = 240$

   The operating profit.

6. Check the lines add back.

   $1560 + 1200 + 240 = 3000$

   Revenue is fully accounted for.

14. Two months at Northside Repairs

1. Lay out March's gross line.

   $4000 - 1440 = 2560; \ 64\%$

   Repairs are mostly skill.

2. Take off March's cost of being open.

   $2560 - 1600 = 960$

   Healthy on both lines.

3. Lay out April's gross line: same revenue, same parts.

   $4000 - 1440 = 2560; \ 64\%$

   The unit has not changed.

4. Take off April's cost of being open, with a second bench.

   $2560 - 2400 = 160$

   The business is nearly flat.

5. Find the operating margins.

   $960 \div 4000 = 24\%; \ 160 \div 4000 = 4\%$

   Same gross margin, very different operating margin.

6. Find the revenue the second bench needs to pay for itself at 64 percent.

   $800 \div 0.64 = 1250$

   The extra takings the new bench must bring in each month.

7. Read the pair.

   $\text{overhead problem, not a pricing problem}$

   Raising prices would fix the wrong line.

15. Your turn: revenue 2880, cost of what was sold 1530, cost of being open 900

1. Find the gross profit.

   $2880 - 1530 = 1350$

   Revenue less the cost of what was sold.

2. Find the operating profit.

   $1350 - 900 = 450$

   Gross profit less the cost of being open.

3. Your turn: work this step out. Its working is at the end of the packet.

   Find the gross margin.

16. Guided practice

Four lines of a profit and loss, and four descriptions of what each one is made of. Match them up.

17. Guided practice

Complete the worked solution: a month took $3400$ dollars; the things sold cost $1870$; being open cost $800$. Lay out the month.

1. Find the gross profit.

   $3400 - 1870 =$ _g

   Revenue less the cost of what was sold.

2. Find the operating profit.

   $(\text{gross}) - 800 =$ _o

   Gross profit less the cost of being open.

3. Find the gross margin.

   $(\text{gross}) \div 3400 \times 100 =$ _m $\%$

   Gross profit as a share of revenue.

4. Find the operating margin.

   $(\text{operating}) \div 3400 \times 100$

   The share of each dollar left after everything.

5. Check the lines add back.

   $(\text{cost of sold}) + 800 + (\text{operating}) = 3400$

   Revenue is fully accounted for by the costs and what is left.

18. Guided practice

Monica's Market Stall took $5000$ dollars last month, the things it sold cost $4000$, and being open cost $750$. What was its gross margin, as a percentage of revenue?

Answer:

19. Practice

An owner at Monica's Market Stall asks: is what I sell worth selling at the price I charge? Which line of the profit and loss answers that question, and nothing else?

• Gross profit — revenue less the cost of what was sold
• Revenue — the $5000$ dollars the month took
• Operating profit — the $250$ left after everything
• The closing balance of the business account at the end of the month

20. Practice

Monica started the month with $712$ dollars of stock at cost, bought $2232$ dollars more during the month, and ended it with $701$ dollars of stock still on hand. What was the cost of what she sold this month, in dollars?

Answer:

21. Practice

Northside Repairs took $4000$ dollars last month. The things it actually sold cost $1440$ to make or to buy. Being open at all — the rent, the insurance, the phone, the advertising, the bookkeeping — cost a further $1600$. Lay the month out as a profit and loss and fill in the two lines the statement works out for itself.

22. Somewhere new

A bicycle courier firm billed $4300$ dollars of deliveries last month. It paid its riders $1500$ for the drops they actually made, including the bags and the packing those jobs used. Its phone contracts, insurance, workshop rent and the app it dispatches on came to $1300$, whether the bikes moved or not. Lay the month out as a profit and loss and fill in the two worked lines.

23. Lesson test

Lesson test: one question per skill, one attempt each, no hints. Your answers are checked when you submit.

24. Test question

Maya's Ceramics took $3000$ dollars last month. The things it actually sold cost $1560$ to make or to buy. Being open at all — the rent, the insurance, the phone, the advertising, the bookkeeping — cost a further $1200$. Lay the month out as a profit and loss and fill in the two lines the statement works out for itself.

25. What you can do now

You can build a five-line profit and loss from a month's figures, including the cost of what was sold from stock counts, and work out the gross margin from it. Tell someone why an owner with a healthy gross margin and no operating profit should not be looking at the price. Next: the same month as cash, month by month, and the month the account goes below zero.

Working for the steps left to you

15. Your turn: revenue 2880, cost of what was sold 1530, cost of being open 900, step 3