The familiar phrase “the bottom line,” used as synonymous with the conclusion or the underlying truth, is actually taken from the standard Income Statement in accounting, which subtracts costs and expenses from sales and shows profits as the bottom line of the statement.

After you have projected sales and cost of sales, you need to think about comparing expenses to your sales.

Expenses start with personnel. Then you have rent, utilities, equipment, and probably some advertising, maybe commissions, public relations, and other expenses.

What we’re leading to is profits. Profits are what is left over after you subtract cost of goods (or sales), expenses, and taxes from sales.

The Income Statement is the same as the Profit and Loss statement. You’ll also find them called “pro forma,” meaning projected, as in “pro forma income” or “pro forma profit and loss.” The pro forma income is the same as a standard income statement except that the standard statement shows real results from the past, while a pro forma statement is projecting into the future.

The first illustration below shows a standard income statement; the format and math starts with sales at the top. (This example doesn’t divide operating expenses into categories.)

Illustration 1: Standard profit and loss statement
Standard profit and loss statement

First, subtract cost of goods (or sales) from sales. This gives you gross margin, an important ratio for comparisons and analysis. Acceptable gross margin levels depend on the industry. According to the recent Financial Statement Studies of Risk Management Association (RMA), an average shoe store has a gross margin of 42 percent. A hat manufacturer has a gross margin of 30 percent, and a grocery store about 20 percent.

A more detailed Profit and Loss analysis, which divides operating expenses into categories, is shown in the next illustration:

Illustration 2: Detailed profit and loss statement
Detailed profit and loss statement

This table divides operating expenses into standard categories, including Sales and Marketing expenses and General and Administrative expenses. It provides a clearer picture of the business expenses and what they stand for, though for some cases the extra detail may not be relevant.

Regardless of which statement style you choose, you make very important choices as you plan your profit and loss; this is where you plan your expenses. You are estimating expenditures across the business, from rent and overhead to marketing expenses such as advertising, sales commissions, and public relations. Decisions you make here are as important as the mathematics are simple. Your sum of expenses ultimately determines your company’s profitability. This is the business plan equivalent to budgeting, as you set your sights on the levels of expenditures you expect your company will need.

As your business moves forward, save a copy of your plan in your computer. Later, plug your actual numbers into the spreadsheets and compare them against your planned numbers. You can make decisive course corrections to your business based on this analysis.

Tim BerryTim Berry

Tim Berry is the founder and chairman of Palo Alto Software and Follow him on Twitter @Timberry.