Finance 101 for Climate Startups: Your P&L

Your climate startup’s profit and loss statement not only helps investors understand your business, it helps you understand it too. Unpacking your P&L tells you what elements are driving your revenue and enables you to make more informed spending decisions that will boost your bottom line. So, what’s included in a clear and accurate P&L, and how can you interpret the data in front of you?

Daim Ashraf is a Senior Associate at Enduring Planet. We sat down with her to learn more about what founders can learn from looking at your P&L, what ratios to track, and tips for staying on top of your financials. This is the first piece in a short series we’re publishing over the next few months, covering core financial concepts for climate entrepreneurs.

Key elements of your P&L

1. Revenue
Your revenue figures are what investors will be most interested in, so it’s incredibly important that they’re accurate. These numbers reveal your company’s historical performance and how well it’s attracting customers, and will be used to determine your future trajectory.  

2. Cost of goods sold (COGS)
COGS - sometimes called cost of materials, direct costs, or cost of sales - encompasses everything that goes into bringing a product or service to a customer in its final shape. This includes materials, but also costs like import and export duties and bank charges.

You can take steps to reduce your direct cost, for instance by shopping around for suppliers to get a better quote. But remember that it’s not always about what’s cheapest - you’re also looking for quality. 

3. Expenses
What’s left after you’ve subtracted your cost of sales from your revenue is what you have to pay your other operating expenses (and have profit left over) (OPEX). These are key operating costs that require you to run your business, but are not directly correlated to your sales or revenue - things like labor, rent, utilities, marketing, etc.  Understanding your expenses (and their changes over time) is a critical piece to streamlining operations, reducing costs, and driving to profitability. 

Key ratios and analyses for any CEO/CFO/COO

1. Gross margin
Your gross margin is the percentage of revenue that remains after accounting for the cost of goods sold, which you can then put towards your other expenses. To investors, a healthy gross margin indicates strong pricing power and a competitive market edge, while a low gross margin can signal pricing pressures, high production costs, or inefficiencies in your supply chain.

2. Net margin
Sometimes known as EBITDA, your net margin takes a broader view, deducting all of your expenses - including operating costs, taxes, interest payments, amortization/depreciation - to show the percentage of revenue that translates into bottom-line profit. For investors, this is the ultimate measure of your business's financial health, as it essentially tells them how much money they’ll make over time.

3. LTV to CAC
This common ratio measures the value of a customer against the cost of acquiring that customer, and is used most commonly in software (although is applicable in any industry). Unlike gross margin, it integrates all the operating expenses associated with securing the customer, such as marketing, sales, customer success, etc.

4. Horizontal and vertical analysis
There are two kinds of analysis you should be doing regularly to effectively understand your P&L (and the financial health of your business). Vertical analysis takes every line item and evaluates it as a percentage of your total sales. This can help you understand how different investments are driving key commercial outcomes in any given time period.  Horizontal analysis involves taking a wider perspective to review your statements on a week to week, month to month, or yearly basis in order to spot trends. 

5. Biggest expense
At all times, you should be tracking which expense makes up the biggest percentage of your overall OPEX. In most cases, it’ll be payroll, or it might be marketing and sales if your business is in a temporary growth phase. If so, your horizontal analysis will help you plan for this uptick in costs and figure out how to make your total expenses work within your budget.

Tips for maintaining your P&L

1. Set up both accrual and cash-basis models
Having an accrual system is crucial for planning ahead, while a cash-basis model gives you an up-to-date and transparent view of how much cash you have left. For more on why you should run these systems in parallel, check out our piece with Shivani Ganguly here.

2. Use well-established software
Never do your bookkeeping in a spreadsheet - things will get messy fast. Use one of a range of tools out there, such as QuickBooks Online (QBO), Xero, Zoho Books, and Wave. QBO is considered industry standard and has the largest number of integrations available with other platforms/API tools/etc.

3. Don’t overcomplicate your chart of accounts
Your chart of accounts is the framework you use for classifying all of your transactions by category in your accounting system. Having a comprehensive and relevant structure enables you to make more informed decisions, but don’t go overboard with infinite categories.  What matters at this stage is keeping it regularly updated, so it’s OK to start with more general categories (Wages, Marketing, etc). You can implement more sophisticated levels of tracking (for example, expanding Wages by team, or Marketing by channel) - and glean the insights - later, when your business grows and you can actually take advantage of the additional insights.

4. Don’t wait to update your books
To really take advantage of your internal accounting, you have to keep on top of your books, ideally completing reconciliations on a bi-weekly (or more frequent) basis.  Then more frequently you make updates, the more signal you’ll have that things are on track, or not.  Make sure when you do make updates, you have all of the supportive documentation saved in your accounting system.

5. When you can’t keep up, hire someone
As a founder, bookkeeping is just one of many tasks you have on your plate. When it starts to fall by the wayside, don’t wait until you have time to pick it up again - seek out support from an external accountant.  You can easily find fractional help that can handle your needs without having to bring on a full-time controller or in-house CFO.  If you’re looking for support, we’d love to help!  Check out our Fractional CFO platform here.

6. Think in trends, not months
More important than the numbers themselves is how they relate to each other, so you should always try to spot trends in your financials. This could help you see where to cut costs - for example, maybe you’ve been spending a lot of money on hiring salespeople, but your sales tend to be inbound, so you don’t actually need as big an outbound sales team. Or you could identify ways to better use the resources you already have. For instance, you might find that every new sales person you hire adds 10% of new revenue within 3 months, but increased commissions for existing sales members lead to a 20% increase in sales over 6 months; in this case, improving incentives might lead to better outcomes than new hires. You can’t come to these realizations if you’re only looking at your financials on a month by month basis.

7. The numbers don’t exist in a vacuum
Your P&L gives you vital information about the financial health of your business, but it isn’t the whole story. You’ll need to stay on top of all the different statements that track your finances. Elements of your balance sheet are interlinked with your P&L, so by looking at them together, you should start to notice trends. For instance, you might see that your revenue is staying flat but your account receivables are going up, so you need to work on collecting the revenue that you’re owed, but haven’t yet taken in.  We’ll cover Balance Sheet basics later in this series.

When to use a more sophisticated system

At some stage, most companies will transition from accessible accounting systems like QuickBooks Online to a more complicated Enterprise Resource Planning tools like NetSuite. This might be because you've got a complex network of subsidiaries or you’re fundraising from large institutional investors and expecting to grow aggressively over the next few years, and you’ll need to provide detailed reports to investors that aren’t supported by simpler software. It will also depend on the industry you’re in and how many suppliers and customers you need to track on a daily basis. If your transactions aren’t that complicated, even if you’re taking in millions in revenue, Quickbooks Online should still work for you. 

For more expert advice on navigating the financial complexities of building a climate startup, sign up below to get these Insights in your inbox every Tuesday!