## Purpose of Profit and Loss Forecast

The purpose of a profit and loss forecast is an estimation of future profitability or losses for a company.

It is the easiest way to understand how much money the business earns and will earn in the future. The net profit of a company shows how much money will come from the business. The net profit is the final line of the profit and loss forecast.

In addition, the profit and loss forecast is an important tool for business owners, CEOs, and managers in making decisions about the company development and updating the strategy.

I will show you why. As the profit and loss forecast **shows the future profitability** of the company, you can see the **factors that influence it** in advance and improve them.

Let’s discuss below** how to improve the business profitability **using the profit and loss forecast.

It can also be used by investors to make decisions about whether to invest in a company.

## How to Improve a Business Profitability Using Profit and Loss Forecast

A **profit forecast** is not an exact prediction of future profitability, but rather an estimation based on the data for previous periods and other factors.

A certain list of variables can impact profitability, they will be considered below in detail.

**The main variables** that can impact profitability include:

- Sales volume;
- Selling prices;
- Costs of goods sold;
- Operating expenses;
- Interest expense;
- Taxes.

To **improve profitability** business owners or managers should think about what action can be taken:

- to increase sales volume and selling prices;
- to decrease expenses: costs of goods sold; operating expenses; Interest expenses; and taxes.

Having the profit and loss forecast, you can see, how can be changed the net profit of the company, when you change even 1 variable.

**For example**, your company sells T-shirts with prints for $12. The company sells on average 200 T-shirts per month and has monthly expenses in the amount of $400. You spend $5 to produce one T-shirt.

In this case, **net profit per month** = $12* 200 units – $5* 200 units – $400 = ($12-$5)*200 – $400 = $7*200 – $400 = $1000

If you increase the selling price or decrease the cost of goods sold to $1, the net profit per month will increase by $200 (by $2400 per year). So, you have 14% of the net profit growth in the case of increasing the selling price or decreasing the cost of goods sold to $1.

**Explanation**: **new** **net profit per month** = $13* 200 units – $5* 200 units – $400 = ($13-$5)*200 – $400 = $8*200 – $400 = $1200

**Net profit growth** = ($1200 – $1000)/$1000*100% = 20%

As you can see, one action led to an increase on the net profit by 20%.

## Steps of Profit and Loss Forecast

**Revenue forecasting:**- Sale volume forecast for each product/service;
- Prices estimation for each product/service;
- Revenue calculation multiplying sale volume on corresponding prices of the product/service;
- Total revenue calculation summarising revenue for each product/service.

**Cost of goods sold calculation:**- Estimation of variable expenses for each product/service;
- Cost of goods sold calculation multiplying sale volume on corresponding variable expenses of the product/service;
- The total cost of goods sold calculation summarizing the cost of goods sold for each product/service.

- Note: If you have no variable costs in your business point #2 can be missed.

**Gross margin calculation**= Total amount from point #1 minus total amount of point # 2.**Fixed monthly cost estimation.**

It can be the monthly rent cost of premises, depreciation amount, salary of staff; taxes, etc.**Net profit calculation**= Total amount from point #3 minus the total amount of point # 4.

## Profit and Loss Forecast Template

A profit forecast is usually done by using a profit and loss statement forecast. Please find below the detailed template of the profit and loss forecast.

Profit forecasts can be done on a monthly, quarterly, or annual basis.

# | Financial indicator | Year 1 | Year 2 … | Comments |
---|---|---|---|---|

1 | Revenue | = Sale volume of product 1 / service1 * Price for product /service 1 + Sale volume of product 2 / service 2 * Price for product /service 2 +… | ||

2 | Cost of sales | = Sale volume of product 1 / service1 * Cost of sales for product /service 1 + Sale volume of product 2 / service 2 * Cost of sales for product /service 2 +… | ||

3 | Gross Margin | = Total amount from point #1 minus total amount of point # 2 | ||

4 | Fixed costs | = Monthly expenses including Payroll costs, rent, marketing expenses, etc. | ||

5 | Profit before tax | = Total amount from point #3 minus total amount of point # 4 | ||

6 | Income tax | = Total amount from point #4 * income tax rate | ||

7 | Net Profit | = Total amount from point #5 minus total amount of point # 6 |

## Profit and Loss Forecast Example of Calculations

**1. Initial data for profit forecast:**

Let’s consider the example of a profit forecast.

The legal firm ‘Oneida’ wants to estimate profit for next year.

It has the following initial data:

**1.1 List of services with prices, the volume of sales, time spent, and staff rates:**

Name of services | Price | Volume of sales | Working hours spent by staff | Hourly rate of staff |
---|---|---|---|---|

Monthly support of clients | 500$ per month | clients in the current year + 1 new contract will be signing off with a new client at the beginning of the year | 8 hours/month per client | 20$/hour |

One-time consultation | 50$ per hour | 10 consultations on average per month | 1 hour per consultancy | 20$/hour |

One-time consultation + writing report | 100 $ per hour | 5 consultations on average per month | 1,5 hours per consultancy | 20$/hour |

**1.2 Monthly expenses include:**

- Rent of office 500$;
- Salary of administrative staff 2000$;
- Depreciation of office equipment 200$;
- Internet & telephony 100$;
- Office expenses 50$.

**1.3. No loan and interest expenses;****1.4. Income tax rate 15%**;

Let’s estimate profit based on the initial data above.

**2.** **Profit and loss forecast:**

# | Financial indicator | Year 1 | Calculation |
---|---|---|---|

1 | Revenue | 60000$ | =500$*8 clients +50*$10 consultations+ 100$ *5 written consultations= 5000$ per month. Revenue per year = 4000$*12 months=60000$ |

2 | Cost of sales | 19560$ | =8 hours* 8 clients *20$ per hour +1 hour*10 consultations *20$ per hour+ 1,5hours*5 written consultations *20$ per hour= 4000$ per month. Cost of sales per year = 1630 $*12 months=19560$ |

3 | Gross Margin | 40440$ | =60000$-19560$=40440$ |

4 | Fixed expense | 34200$ | =500$ for office rent + 2000$ for salary of administrative staff + 200$ for depreciation of office equipment + 100$ for Internet & telephony + 50$ for Office expenses =2850$ per month. Fixed expenses per year = 2850$ *12 months= 34200$ |

5 | Profit before tax | 6240$ | =40460-34200=6240$ |

6 | Income tax | 936$ | =6240$*15%=936$ |

7 | Net Profit | 5304$ | =6240$-936$=5304$ |

## Conclusions in Profit Forecast

- You need to have the initial data for profit forecasting (ex: list of products/services, their prices, and volume; sales, amounts of expenses), thus you need to understand your business. The full list of the initial data for profit forecasting is in the example above;
- You need to analyze the profit forecast after it is calculated (Ex: Is it a response to your expectations; how it can be improved; if it is possible to increase the profit; what actions are necessary for increasing the profit);
- As you see from the calculation, the profit can be increased by:
- Increasing prices;
- The increasing volume of sales;
- Decreasing expenses.

So, you need to check if possible for your business.

You can see in the example that the profit is enough low and should be improved;

- This is a simplified example of the profit forecast, using it you can understand the basics of finance. Although, depending on your business the calculation can be more difficult.

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