In this final installment of our Summer Series on understanding ecommerce financials, we analyze the Profit and Loss (P&L) statement to identify issues and opportunities that can drive better business decisions. If you missed part 5, you can catch up here. A solid grasp of your financial data is not just about knowing the numbers but about uncovering the story behind them, especially for ecommerce businesses that often operate on thin margins.
Why Start with the Balance Sheet?
Before diving into the P&L, ensuring that your balance sheet is accurate and balanced is crucial. A well-reconciled balance sheet sets the foundation for a reliable P&L analysis. Minor discrepancies, like a $300 issue in a $100k revenue business, may not be a deal-breaker. Still, significant issues, such as five- or six-figure discrepancies, should halt any in-depth analysis until resolved. This foundational check is vital to ensure you’re making decisions based on reliable data.
Reading the P&L: Key Metrics to Watch
Once the balance sheet is in order, the next step is to review the P&L for your target period. For this example, let’s consider the period from February to April. Observing the P&L with percentages on the side can help identify anomalies or trends. It’s essential to analyze sales by channel—Amazon, Shopify, wholesale, etc.—and look at key metrics like refunds, promotional discounts, and net sales to understand how each channel performs.
In this case, our P&L shows a 50/50 split between Amazon and Shopify sales, with a small percentage in wholesale. Refund rates are within normal ranges—under 4% for Amazon and 2% for Shopify. However, one glaring issue stands out: a disproportionately high advertising spend. The advertising budget is significantly out of proportion compared to other expenses, resulting in a post-advertising gross profit (PAG) of only 11.32%. This PAG figure is far too low for sustained profitability.
Identifying Issues and Forming an Action Plan
With the low PAG as a clear indicator of trouble, the next step is investigating the root cause. Compare the current period’s advertising expenses to previous periods. In this example, when comparing February to April with the last three months (November to January), it becomes evident that advertising spending has increased substantially—from 43% to 57% of sales. Both percentages are problematic, but the upward trend is particularly concerning. This pattern suggests a worsening situation that demands immediate attention.
Going Deeper: Analyzing Trends and Taking Corrective Action
For ecommerce businesses with seasonal fluctuations, it’s helpful to compare current performance against the same period from the previous year. For instance, while this business saw a 10% increase in overall sales year-over-year, its cost of goods sold (COGS) remained stable, thanks to supply chain negotiations. Despite these gains, the advertising budget also increased by more than 10%, which eroded the additional profit potential.
A more granular analysis is necessary to pinpoint the exact causes. Exporting data from QuickBooks into Excel or Google Sheets allows for a deeper dive. By examining line items, you might find duplicate or inefficient marketing expenditures. In one real-world example, renegotiating vendor contracts and optimizing marketing management resulted in significant improvements within a few months. This case underscores the importance of digging deep and taking action based on data-driven insights.
Leverage Financial Insights to Drive Success
In ecommerce, every dollar counts. The ability to analyze your P&L effectively and identify areas for improvement—like runaway advertising costs—can be the difference between a thriving business and a struggling one. Don’t leave your profitability to chance. By partnering with a firm specializing in ecommerce financials, like Seller Accountant, you gain access to the expertise needed to make informed decisions that drive cash flow and profitability. If you’re ready to optimize your business’ financial performance, connect with us today to learn how we can support your growth.
For a deeper dive into these topics, check out the latest episode of our podcast here.