How To Manage Profit & Loss For Freelancers & Agencies

It’s the end of the quarter and you’ve just run your first small business profit and loss statement. Now here’s the big question – what do you do with it?

If you don’t have a background in finance or accounting, tracking your business finances can feel awfully abstract. But profit and loss management is surprisingly straightforward, once you clear that initial learning curve.

In this guide, I’m going to take the mystery out of profit & loss (P&L) management. I’ll start by talking about what P&L statements are for and then I’ll talk about how you can create one. I’ll then spend the rest of the article discussing useful questions which you can use to interpret your P&L.

Just a quick note here – I’m assuming that you are running a freelance or small agency operation in the US. That means you are probably a sole proprietor or single-member LLC. But if that doesn’t describe you, you will still find about 80% of this to be relevant to your situation all the same.

What is a Profit & Loss Statement?

A P&L statement, also known as an income statement, is a financial statement that shows how much your business has earned and spent over a certain period. It’s one of three major financial statements that businesses rely on, with the other two being the balance sheet and the cash flow statement.

(As a quick recap: balance sheets show who you owe and who owes you. Cash flow statements show where money comes from and where it goes.)

Your P&L accomplishes one important task: it shows your company’s overall profitability. To make one, you start with your total revenue, which is the “top line” of the statement. Then you take out your expenses, which includes cost of goods sold (COGS), operating expenses, and other expenses that don’t neatly fit into the other two categories.

At the bottom, you see your net income. If you’re running a freelance operation or a single-member LLC, that bottom line is basically your take-home pay.

If you’ve turned your side hustle into your main hustle, you’ll probably notice that the new gig doesn’t come with pay stubs! So if you’re used to being an employee, it can be a bit of culture shock – at least until you get used to reading financial statements.

An example of a P&L statement that is close to my preferred template as an example.
An example of a P&L statement that is close to my preferred template as an example.

How do you make a Profit & Loss Statement?

I have a longer guide on how to create a P&L here. But I’ll give you a brief explanation in this article because you will need the additional context before proceeding. My logic here is that you can’t do any kind of meaningful profit & loss management or analysis without understanding how the P&L is made.

For this, you will need to understand the different sections found on a P&L statement.

Sections on a Profit & Loss Statement

My preferred method of creating a P&L is based on the standard Quickbooks report with a couple of recommendations from my accountant that slightly deviate from the norm. This is because we mutually agreed that this method is well-suited for a service-based, single-member LLC business. Feel free to modify as needed for your business.

With that in mind, here are 13 sections found on my preferred P&L statement template:

  1. Income: The overall amount of revenue your company has generated in a period of time. Each source can be its own line item.
  2. Total Income: A tally of all the sources of income into a single number.
  3. Cost of Goods Sold (if applicable): “If you produce physical products, you will also need to deduct cost of goods sold (COGS). The idea of cost of goods is that you take out the direct costs associated with producing the goods from income. This might include materials and labor.” Often does not apply to service-based businesses.
  4. Gross Profit: Total Income minus Cost of Goods Sold.
  5. Operating Expenses: The overall amount of tax-deductible expenses your company has incurred in a period of time. Each source can be its own line item.
  6. Total Operating Expenses: A tally of all the sources of operating expenses into a single number.
  7. Net Operating Income: Gross Profit minus Total Operating Expenses. 
  8. Other Income: Any income that comes from activities not related to your business, such as interest on your savings account.
  9. Total Other Income: A tally of all the above line items.
  10. Other Expenses: I like to separate my “benefits” expenses from operating expenses. That includes my personal retirement, healthcare, and money spent on quarterly filings.
  11. Total Other Expenses: A tally of all the sources of other expenses into a single number.
  12. Net Other Income: Total Other Income minus Total Other Expenses.
  13. Net Income: Net Operating Income plus Total Other Income minus Total Other Expenses.
Weird stock photo I found of people pointing at a bar chart.
Once you know how to make a P&L, reading one is as easy as pointing at a bar chart!

Here are the most important sections

It’s still overwhelming to look at a statement with 13 major statements. So to help narrow your focus, I would like to direct your attention to the five that I consider to be the most important. Here are my layman’s explanations of each:

  1. Total Income: The amount of money going into your company.
  2. Total Operating Expenses: You can call it business expenses or operational costs if that makes it easier. This is the amount of money you spend providing services, paying staff, and “keeping the lights on.”
  3. Net Operating Income: This is your “gross pay” or your “salary.”
  4. Other Expenses: The way I use it, this is my “benefits” (retirement, healthcare, etc.) and my “withholding” (money set aside for quarterly tax filing).
  5. Net Income: This is your “take-home pay” or what your paycheck actually looks like when you check your bank balance online.

I like to look at P&L statements this way because it helps ground complicated business decision-making in ways that feel more intuitive. Instead of thinking about the business as a Business™, you can imagine it as a mix of two things people have more experience with – a household budget and a paycheck.

That makes it way easier to ask the questions you need to be asking to keep your business alive and well.

Questions to ask when reading your P&L

As a business owner, you need to pay attention to your P&L, because it’s one of the best gauges of success you have. That’s why I want to share with you five questions that I like to ask myself when reviewing my own P&L statements to make sure I create a profit…not an expensive hobby!

1. Am I making enough net income?

Remember – your net income is basically your “take-home pay.” Small business owners have personal bills to pay too! That means the mortgage, groceries, childcare, and all that other fun stuff that seems to inexorably nudge our bank accounts toward zero.

Put plainly, if you are not making enough money for yourself, something needs to change. That might mean raising your rates, onboarding new clients, or introducing new product or service offers. Alternatively, you might find yourself cutting expenses.

What you do is up to you and your situation, but one thing is for sure – if you’re not making enough to be comfortable, something has to change!

Keep an eye on your income - it's one of the best indicators of overall financial health!
Keep an eye on your income – it’s one of the best indicators of overall financial health!

2. How much am I spending on other expenses?

One of the confusing things about running a small business is that some expenses fall into that weird hinterland between “business” and “personal.” If you are a sole proprietor or single-member LLC owner in the US, for example, you have to file some expenses on your personal 1040 and others on your business’s Schedule C.

If you follow my method, “other expenses” will include money set aside for quarterly tax filing and personally tax-deductible expenses for retirement, healthcare, and so on. In other words, these are your “withholding” and your “benefits” – the line items that would have shown up on your pay stub at your day job.

Periodically, it’s a good idea to ask yourself if your other expenses are where they need to be. Are you overpaying on taxes? How about healthcare? Are you putting enough into retirement, or so much that your net income is too low?

3. Are operating expenses too high?

You do have to spend money to make money, at least to some extent. You might need software or supplies, and perhaps the labor of some contractors or even employees on payroll.

That’s all fine and normal, and part of why you charge a lot more than you would get paid to do the same job at a company. But if you find yourself getting crushed by operating expenses, it might be worth cutting back on them through any means appropriate for your situation.

You’re on a finance blog, so I don’t need to tell you that it’s good to save money! But keep in mind that it’s not always good to go too cheap on expenses. If you can swing it, pay for nice tools and good workers. Smartly spent money is an investment in your company’s success, and besides, business expenses are tax-deductible!

4. What operating expenses can be cut?

Even if your overall operating expenses are sufficiently low, it’s still worth considering if there are any that you can cut. The P&L gives you a chance to break out your expenses by line item, so this is a good chance to catch all the software subscriptions you keep forgetting to cancel!

5. Is the company bringing in enough revenue?

No matter how faithful a steward you are of your expenses, if you are really interested in boosting your net income, you have to look at the top line. The simple fact is this – there is a limit to how much you can cut expenses. There isn’t a strict limit to how much money you can make.

Look at your overall revenue and ask yourself if it is as high as you would like it to be. If not, think of how you can get to that point.

You might also consider looking at the number of distinct sources of revenue your business has as well. If you have high client concentration – that is, a large percentage of your revenue comes from a single client – you may need to think about how you can diversify your sources of revenue. That way, if you lose your major source of revenue, your business can remain healthy.

Final Thoughts

Your P&L statement is the single most important financial document your business will produce on a regular basis. Knowing how to read one and what to do with that information will make it much easier to make savvy business decisions in the long run!

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