Your P&L Statement Misleads You:
Learn to See the Core in Financial Reports
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Look at your P&L statement.
If you’re in the black, it doesn’t mean you’re okay.
It isn't a reason to panic if you're in the red.
Examine your numbers from a completely different, strategic angle.
Nokia story
In 2007, Nokia had a record net income of 7.205 billion euros.
According to Forbes, in 2007, one billion users worldwide had devices with Nokia’s logo in their pockets.
"Can anyone catch the cell phone king?" asked the magazine.
The media love to 'crown' people, but it often turns out that these emperors had no clothes.
That Forbes issue was published in November 2007. Sales of the first iPhone started in August, and initially, they didn't show sensational numbers.
It seemed that Nokia’s leaders could sleep peacefully.
You know the end of the story. The Nokia case has been researched inside and out. There is even a scientific study on the topic. I am not going to go into detail about the case. But the fact that the company received a record net income in 2007, the year its epic failure began, can provide food for interesting thought.
Business as a continuous game
Simon Sinek famously said business is an infinite game. When we play football or tennis, we know that the game will inevitably come to an end. The score will show us who won.
When Germany crushed Scotland 5-1 in the opening match of the 2024 UEFA European Championship, nobody doubted who the winner was.
The game called business never ends – as long as the company exists.
However, business is not only an infinite game. It is also a continuous game, not a discrete one. But we often fall into the trap of dividing time into discrete spans, such as months, quarters, and years.
We not only split our business life into imaginary 'quarters' and 'months,' but also came up with specific rituals such as planning discussions and reports.
Every quarter, we play a silly game in which subordinates try to persuade bosses that expenditure targets should be increased while income goals must be lowered. The bosses counter-attack.
It creates a dangerous illusion that a new page in our company's life ends every quarter, and another one begins.
But life doesn't consist of pages; it is an ongoing flow.
Every day, month, and quarter you:
1. Fix the problems that are the result of your previous mistakes.
2. Manage the current situation.
3. Lay a foundation for future success.
Like Doc Brown from Back to The Future, you must think multi-dimensionally.
And you should know what you spend every penny on.
But financial reports won’t help you to do so.
The distorted magic of P&L statements
Any profit and loss statement basically consists of two major parts: your current income (revenue, gross profit, etc.) and your current expenditures.
However, not all expenditures are the same.
Unfortunately, your traditional P&L statement will never tell you how much you spend on fixing past problems, managing current situations, and laying a foundation for the future.
For instance:
1. You reduce the price for a product because it appears to be not as good as you had expected, and sales are far from the target. This solution for the past mistake lowers your income.
2. You hire a highly paid, savvy CMO and expect them to improve customer communications. You pay them a salary from the first day of their work, but these investments won't pay off immediately.
3. You arrange a training course on strategy for your executive team. Even if it goes very well, you won’t see tectonic shifts overnight.
4. At the same time, you may receive significant revenue from products developed years ago.
Why is it so important?
Your P&L statement mixes together the revenues and losses related to past decisions, as well as your expenses associated with the past, present, and future.
It happens because business is a continuous game, but a P&L statement always covers only a particular short period.
If you're in the black, you receive excess profits from your past and present decisions but then pay imaginary 'taxes' for past mistakes and future development.
· If you suffer losses because of previous mistakes, it will end sooner or later.
· If you benefit from your past successful decisions, it will end soon as well, unfortunately. You need to make great new decisions for your future.
· Paying bills for today's needs is okay – as long as you don’t pay too much.
· If you don’t spend enough on your future development, you won’t have the future.
P&L statement – strategic approach
You should analyze your P&L statement strategically.
Ask your CFO to help you divide all your profits and losses for a period into six groups:
1. Revenue streams you receive from long-ago decisions, for instance, from products developed more than a year ago.
2. Losses of revenue due to your yesterday’s mistakes.
3. Revenue streams from your new products or decisions made less than a year ago.
4. Expenditures you incur due to your past mistakes.
5. Expenditures you incur to maintain today’s operations.
6. Expenditures you incur today to give your business a chance to celebrate its next birthday.
Look at the numbers.
If you spend or lose too much because of your past mistakes, analyze them thoroughly.
If you don’t get a significant part of your revenue streams from your recent decisions, you may face difficulties shortly.
If your symbolic ‘tax’ on future success is inconsiderable compared to today's spending, you may undermine your business's ability to live long.
Nokia and profits
Some experts believe that Nokia’s executives were blinded by current profits. Living by the motto 'if it ain't broke, don't fix it' and ‘perfect is the enemy of good,' they developed new products too slowly.
If a product brings you a lot of profit, it isn't a reason to drink champagne. It's a reason to ask yourself: "Am I preparing my business to the times when it is over?"
Read also: The Dangerous Trap of Experience: How vast expertise can lead to wrong strategic decisions
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Good point of view. Dashboard-like data doesn’t tell the whole story.