Introduction to Skeletal Profit and Loss Statement: Calculating the P & L Components

Welcome to the (Section 2, Part 2): Skeletal Profit and Loss Statement: Calculating the P & L Components course. “Skeletal Profit and Loss Statement: Calculating the P & L Components” addresses the format, construction and calculation of the Skeletal P & L Statement. It examines the relationship of Net Sales, Cost of Goods Sold, Gross Margin, Operating Expenses and Operating Profit plus the interrelationships among the components. Additionally, Part 2 discusses how to adjust the four Profit Variables (i.e., retail price, sales volume, cost of goods sold, operating expenses) to increase store profit.

 

We recommend printing off the course content reference guide via the button below to assist you in the Manipulating Profit Variables: Merchandising for a Profit courses.

 

Basic Components of the P & L Statement

SECTION 2: Manipulating Profit Variables: Merchandising for a Profit

 

Part 2: Skeletal Profit and Loss Statement: Calculating the P & L Components 

Part 2: 2-1 Basic Components of the P & L Statement

 

As previously discussed, the major components of the skeletal P & L statement include:

 

  • net sales
  • cost of goods sold
  • gross margin
  • operating expenses
  • (net) operating profit

 

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. Cost of goods sold has many subcomponents which may be manipulated in order to control 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.

 

In the next segments of Part 2: (2-2 – 2-6) each skeletal P & L Statement component will be discussed in detail and formulas will provide the mechanism for calculating each component.

Net Sales

“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 are not illustrated on 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…”

 

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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 $

 

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Gross Margin

“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…”

 

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Operating Expenses

“Operating expenses is 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 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…”

 

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(Net) Operating Profit

(Net) Operating Profit $ = Gross Margin $ Operating Expenses $

(Net) Operating Profit % = (Net) Operating Profit $ ÷ Net Sales $

(Net) Operating Profit % = Gross Margin % – Operating Expenses %

 

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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…”

 

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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…”

 

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