P&Ls: The Backbone of Ecommerce

This is my first newsletter. I don’t know my audience, so I don’t know if you’re a sophisticated CEO who graduated from Harvard Business School, or a new entrepreneur who is about to launch their first business. That means it is really hard to write this, because I’m not sure who I should write for. As a result, I’d really love your feedback on this newsletter. If you like it, please DM me on twitter and tell me why. If you hate it, please DM me on twitter and tell me why too!

I wanted my first newsletter to focus on the most important thing any business does, which is understanding how much money you’re making or losing. And that means I focused on building profit and loss statements or (“P&L”)

The P&L is the backbone of any business. It helps you understand how revenue you’ve generated and what your expenses are. It tells you if you’re making or losing money, and tells you how healthy your business is.

It’s different from a balance sheet. When I was learning about these things in law school, my professor put it like this:

A balance sheet is like a photograph. You capture exactly one moment in time, and write down all your assets (cash, inventory, etc.) and your liabilities (your debt, etc.). The date of a balance sheet is “AS OF”. Like as of August 13, 2023. It has only one date - the date you took the photograph.

A P&L is like a video. You look at something over time - usually a 30, 90, or 365 period. You write down how much revenue you made, and your expenses. It has a time period. Like July 1 - July 31, 20223.

While many people rely on fancy accounting tools to build one, I’d recommend you build your own P&L from scratch every month for at least the first year that you own your business.

I built every P&L statement for Native from the day we launched the business until about 2019 (two years after our sale). At the beginning, this took about an hour to build our P&L. As the business got more complicated, it took 4-5 hours, but here’s why I did that.

1. It required me to go through our credit card statements and look at every line to see where we were spending money.

   1. I’d often flag dumb marketing expenses or software that I was using and didn’t need, so I could reduce expenses in the future.

   2. Once, I caught an employee expensing dog food on his/her (I’m being intentionally vague) company credit card. When I slacked him/her about it, they knew that they could never do this again because I was hawk about expenses.

2. It allowed me to better understand on a macro level things I should understand, like marketing spend as a percentage of revenue.

3. It allowed me to better understand on a micro level things I should understand, like google ad spend as a percentage of revenue and a percentage of all marketing spend.

Simply put, I’m certain you will be a better operator if you do this yourself for as long as you can.

Some people build P&Ls on a daily basis, but that is crazy and takes too much time. Some people do this on a quarterly basis, but that is too long. You should do this every month. You can’t do this on the first of the month, because Stripe takes a few days to get you your revenue numbers for the past month. Usually, the earliest you can complete your P&L is the 5th of the next month.

Here are the biggest mistakes people make when building their P&L.

1. Accrual v. Cash

   1. Let’s say you purchase 10,000 sticks of deodorant from your manufacturer on July 1st for $1.00 each. You pay an additional 50 cents for each component of deodorant, and 10 cents for each label. You have terms from all of your suppliers, so you don’t have to shell out cash until September. In July, you sell 472 sticks of deodorant.

      1. In July, your “cost of goods sold” should be 472 sticks, or 472 *1.60 (manufacturing + component/cap/label).

      2. You should not expense all 10,000 even though you received them. That would leave you with a huge, and inaccurate, loss. Simply put, you still have 9528 units to sell next month. You should accrue your cost of goods sold based on when you sell the item, and not based on when you purchase the item or receive the item

      3. You should not expense zero sticks because you have not shelled out any cash for them. You have to expense your inventory as you sell it!
         

2. Gross revenue v. Net revenue

   1. I’m not sure why, but oftentimes, people will claim their “gross revenue” is revenue before discounts. For instance, if you have a welcome offer that is 20% off a given order, you might say your gross revenue is the amount of revenue you collected before the 20% coupon was taken off, and your net revenue was the actual dollars received.

      1. I imagine that when people do this, it isn’t a mistake - it is actually to inflate their revenue. It is a lot easier to get to $20 million in revenue if you have an extra 20% on each sale.

Here are a few mistakes I think people should make on their P&L.

1. Gross Revenue v. Net revenue. Technically, your revenue is your revenue (after discounts) less disputes, credit card processing fees, and refunds. I don’t like using this definition because I think it makes you forget to look at disputes, processing, and refunds. It’s important to look at each of these 3 monthly.
   

   1. There isn’t a ton you can do about disputes, but you can negotiate credit card processing fees everytime you hit a new milestone ($100K per month, $500K per month, $1m per month). In fact, it’s my favorite thing to negotiate because the only thing that happens is your profit goes up without a worse consumer experience.

   2. Understanding the percentage of refunds or returns you see on a monthly basis is really important. This will vary wildly across industries (Ben at True Classic said his return rate was ~10%, while Native’s was less than 1%). But you should look at the trends of this number every month.

2. Recognizing Revenue. Technically, you should realize revenue from an order when you ship the order. So if an order is placed on June 30th and ships out July 1, the revenue should be “realized” July 1. Well, I never did that. It is too hard operationally to understand what orders shipped out when. You can recognize revenue (and the associated cost of goods sold) right when the order is made.

3. Freight. The right thing to do is to build the cost of freight into every single order. Let’s say it costs you $1.00 to purchase an item for your manufacturer and $0.10 per item to ship it to your shipping facility. Technically, your Cost of Goods Sold is $1.10. However, I’ve found that the 10 cent freight varies wildly and is impossible to accurately build into your cost of good sold. So I just call it $1.00, and expense the freight as I incur it (cash rather than accrual basis).

I think the biggest takeaway from this newsletter though should be this sample P&L.

Before I start, let me say it isn’t a real P&L. It isn’t from Native or anyone else. But it does break down revenue + expenses in a way that makes sense, and categorizes them well enough. More importantly, the percentages are real. That is, you should look at the percentages of each expense and consider it a fair benchmark in the ecommerce industry. That doesn’t mean it is true for everyone. Apparel companies are going to have higher returns than deodorant companies. But it does give you general benchmarks you can shoot for.

Here are a few thoughts on this P&L in particular.

• COGS. You might notice that your marketing expense dwarfs your cost of product sold. That isn’t unusual - it is common. Almost always, your marketing expense will be higher than your cost of product sold.

  • Your Cost of Product (not COGS) should be less than 30% of your revenue. If it is higher, you will have an uphill battle making money on your business. It isn’t impossible, but it isn’t easy.
    

• Marketing Spend. I think your marketing spend should be between 25-40% of revenue. It should be on the higher end if you are a new business that is growing quickly, and on the lower end if you are a mature business. There are good reasons that your marketing spend may be higher, like if you sell a one-time item (think a mattress or a sofa), but higher marketing expense is the exception and not the rule.
  

• Salary. Your salary should not be higher than 15% of revenue if you are a DTC business (excluding founder salary). If it is, you should think about whether everyone on your staff is contributing as much value as you should expect.

I hope this helps outline the dos & don'ts of P&L for your company.

Please feel free to share your P&L with me for advice and I will keep it confidential.

As a reminder, please tell your thoughts on this newsletter via twitter