Skeletal Profit & Loss Statement
Calculating the P & L Components (Section 2, Part 2)
This section covers:
- P&L Statement Components
- Net Sales
- Cost of Goods Sold
- Gross Margin
- Operating Expenses
- (Net) Operating Expenses
- Interrelationships Among Components
- Profit Variables
We recommend printing off the course content reference guide to assist you in the second section of How to Think Like a Buyer courses: Manipulating Profit Variables: Merchandising for a Profit.
Basic Components of the P&L Statement
Net sales are the beginning of the P&L statement and all other components of the statement are compared as a percentage of a store’s net sales. The volume of net sales or operating income ultimately dictates all store operations and, both net sales and cost of goods sold, or total cost of merchandise purchased by the retailer, impacts the amount of gross margin attained. The cost of goods sold has many subcomponents which may be manipulated in order to control the cost of merchandise and, in the end, the gross margin of the store.
As previously stated, gross margin is the result of the calculation of the relationship of net sales and cost of goods sold. Profit is calculated from the impact of operating expenses (i.e., direct, indirect, and variable expenses) on gross margin. Therefore, the retailer must carefully monitor and evaluate, throughout the retail year gross margin and profit in order to make adjustments or improvements in sales volume and/or cost of goods sold. Moreover, the retailer may need to adjust operating expenses in order to reach planned performance goals.
The end results or bottom line of the P & L Statement alert the retailer of profit made or loss incurred. Some discussion has occurred in the industry regarding the terminology “net operating profit” and “net profit”. Net operating profit is the profit before taxes are paid or the difference between gross margin and total operating expenses; it is sometimes stated as “operating profit” or “net profit before taxes”. However, some companies designate net profit as “profit after taxes”. Some income statements itemize profit as Net Profit before taxes and Net Profit after taxes as the bottom line. In this section, operating profit will be profit without the deduction of taxes and net profit will be profit with the deduction of taxes or the bottom line for the retailer.
The skeletal P&L statement invisibly begins with gross sales minus customer returns and allowances. However, the calculation of gross sales minus customer returns and allowance is not illustrated in the skeletal P&L statement format. Gross sales are the total retail price, both charge and cash, paid by the end consumer to the retailer for all merchandise and services before any deductions for customer returns and allowances.
Cost of Goods Sold
- Cost of Goods Sold $ = Net Sales $ – Gross Margin $
- Cost of Goods Sold % = Net Sales % – Gross Margin %
- Cost of Goods Sold % = Cost of Goods Sold $ ÷ Net Sales $
Gross margin is the difference between net sales and total cost of goods sold. Gross margin, then, is based on the achieved markup and the net sales dollars figure. The dollar amount of gross margin must be large enough to cover both operating expenses and (net) operating profit. Otherwise, the store will incur a loss! If gross margin is not greater than operating expenses, the retailer is “in the red” and has a loss. On the P&L statement, a loss is shown as a dollar amount and percentage, with both recorded in parentheses. If gross margin is greater than operating expenses, the retailer is “in the black” or has realized (net) operating profit.
Operating expenses are money needed for a business to function or operate on a daily basis. Cost of goods sold is not included in these expenses. Any business, regardless of whether the organization is brick-and-mortar, online, or in another format, incurs costs while providing goods and services for the target consumer. Retailers identify these costs as overhead or the operating expenses for running the business.
(Net) Operating Expenses
- (Net) Operating Profit $ = Gross Margin $ Operating Expenses $
- (Net) Operating Profit % = (Net) Operating Profit $ ÷ Net Sales $
- (Net) Operating Profit % = Gross Margin % – Operating Expenses %
Interrelationships Among Components
After studying the various components of the skeletal P&L statement, it should be evident that all of these components are interrelated. Thus, if one component changes, either upward or downward, other components will be impacted. For example, if operating expenses increase then a chance exists that the retailer could have a loss on the bottom line, rather than the profit expected. Or, if net sales decrease and cost of goods sold increase, there will be a major impact on the amount of gross margin. Then the retailer must evaluate and monitor operating expenses in order to assure that the store is profitable.
Four Variables Adjusted for Profit
Since profit is essential to a company’s existence, it is imperative that all functions and activities of the retail establishment focus on profit. Astute retailers know that the retail price component and the skeletal P&L statement components of net sales or sales volume, cost of goods sold, and operating expenses may be manipulated to increase profit or meet profit goals when other components impact profit negatively. Thus retailers constantly strive to increase sales volume, negotiate for lower costs of merchandise or shipping and handling costs, and control operating expenses. If these components are manipulated in combination, the retailer can usually reach planned profit goals.