Mini Episode: Reading Your P&L Hurting Your Brain? Try This!
Episode Summary
In this mini episode of the Free To Grow CFO podcast, Jon Blair discusses how to effectively organize your Profit and Loss (P&L) statement to maximize insights for Direct-to-Consumer (DTC) brands. He emphasizes the importance of understanding the difference between fixed and variable expenses and how to calculate profit using contribution margin. By reorienting the P&L to focus on contribution margin before and after advertising, businesses can better assess the impact of their advertising spend on profitability. This approach allows for clearer insights into financial performance and helps identify areas for improvement.
Key Takeaways:
Not all expenses are made equal; understand fixed vs. variable expenses.
DTC brands need to isolate fixed overhead in their P&L.
Reorient your P&L to focus on contribution margin.
Episode Links
Jon Blair - https://www.linkedin.com/in/jonathon-albert-blair/
Free to Grow CFO - https://freetogrowcfo.com/
Transcript
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Jon Blair (00:01)
Does it hurt your brain to make sense of your P&L every month? Well, you're in luck because I've got a solution for you today. Hey everyone, welcome back to another mini episode of the Free To Grow CFO podcast, where I break down one key concept that will help your DTC brand increase profit and cashflow as you scale. I'm your host, Jon Blair, founder of Free To Grow CFO, and today we're gonna dive into exactly how you should organize your P&L to maximize insights. Okay, so to start, Profit equals revenue minus expenses, right? Wrong.
Profit equals contribution dollars minus fixed overhead dollars. Why does this matter? Revenue minus expenses equals profit technically is right, but it doesn't pay homage to the fact that not all expenses are made equal. There are two different types of expenses. There are fixed expenses and there are variable expenses. Fixed expenses, just as the name suggests, stay the same every single month, regardless of revenue going up and down. Variable expenses or variable costs go up and down correlated with revenue. Usually they're order level or unit level expenses or costs. so contribution margin minus fixed overhead equals profit pays homage to the fact that there are variable expenses and fixed overhead expenses.
So the way you should actually set up your P&L is revenue minus landed product cost equals gross profit minus shipping and fulfillment and merchant and credit card fees equals contribution margin before advertising. Then, subtract advertising equals contribution margin all in including advertising minus fixed expenses equals profit. Doing this will allow you to see how your business operates on the margin or incrementally. Now when I say on the margin, I don't mean margin in terms of like margin dollars divided by revenue, gives you a margin percentage. On the margin, so when you hear people talk about like what's the marginal impact or what is the incremental impact, it means that what is the impact of the next dollar?
So when we've now reoriented our to measure gross profit, contribution margin before ads, contribution margin after ads, and fixed overhead, we can look and see how those metrics as we scale sales volume up and down. And I think most importantly for a DTC brand, you can see if contribution margin dollars go up as you scale ad spend.
Because if, as you scale ad spend, contribution margin dollars go down, what's happening is a fixed overhead stays fixed and contribution margin dollars go down. That means scaling ad spend is reducing your bottom line profitability. So now we're all of sudden able to isolate the impact of scaling up and scaling down. And again, probably most importantly for a DTC brand scaling up and scaling down through advertising spend, we can ultimately assess the impact on bottom line profitability because we've isolated fixed overhead and we've put that at the bottom of the P&L to be subtracted after contribution margin dollars. So it's all about understanding the impact of different incremental decisions. Most of it will be ad spend and sales volume on contribution margin dollars.
Furthermore, splitting out your contribution margin into what we at Free to Grow CFO call gross margin and then contribution before ads and then contribution after ads allows us to graph out on a time series the relationship of your product cost to sales price, your product cost less shipping fulfillment and credit card fees compared to your sales price, and then your margin inclusive of landed product cost, shipping fulfillment, credit card fees, and ad spend in relation to your sales price. So it helps us to quickly identify if your contribution margin going up or down is because of product cost issues, shipping and fulfillment cost issues, or ad spend issues. look, in summary, you should reorient your P&L to not be revenue minus expenses equals profit, but instead to be contribution margin dollars minus fixed overhead equals profit.
Furthermore, at Free to Grow CFO, we suggest and do this for all of our clients. We split out contribution margin dollars into gross margin dollars, contribution margin dollars before ads and contribution margin dollar after ads. Do this. And now all of a sudden that, that brain hurt from trying to make sense of your P&L goes away. And all of a sudden the insights just start popping out at you.
