A Detailed Guide for Preparing a P&L Table

P&L forecasting, whether for entering a new market segment, establishing a new business segment, or launching a new product/service, is often perceived as a daunting task. Ultimately, this process relies on revenue, cost, and profit calculations which vary for each industry and business model. A P&L table is derived from various parameters based on assumptions and forecasts. The first step is to define all the parameters which will provide input to the P&L on a hierarchical map.

You can download the Hierarchical Map of P&L Parameters in PDF format as follows:

Hierarchical Map of PL Parameters.pdf

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A product/service is developed, produced, promoted, sold to deliver a set of value propositions to target customer segments by a mix of channels. All decisions regarding a business model or a product idea determine the revenue, cost and profit structure. P&L is prepared based on two domains: Product and channel.

P&Ls should be prepared as different scenarios.

PRODUCT DOMAIN

Product domain includes processes from product development to warehousing. In this domain, parameters such as product revenue, cost of goods sold (COGS), gross profit, operating expenses are determined. Before conducting the analysis, various documents such as the business model, operating model, and business plan should be thoroughly examined. At this point, it is essential to have a deep business understanding.

An Example of Operating Model Map

1. Market Characteristics

Before determining the financial figures, detailed examination of reports on target markets and market segments is necessary:

• Country Potential

  • Political situation, stability and conjuncture

  • History, trend and future assumptions on the country economy:

    • GDP, GNI (Gross National Income), GDP per capita, Gini coefficient, personal and household disposable income

    • Consumer spending and distribution

    • Inflation rate, purchasing power parity, currency exchange rates (local currency vs. US dollar&euro), and interest rates (country's central bank, FED, ECB)

  • Market growth in terms of value and volume (history, trend and forecast)

  • Development of other industries affecting the focused industry (e.g. tourism, sports, construction)

  • Social context: Country population and demographies (distribution of age, gender, education and occupation, birth rate, participation in business life etc.), social trends, lifestyles, social values, special days etc.)

• Customer Segment Potential

  • Population size and demographies of the segments

  • Customer behaviours, usage&attitude (U&A)

  • Customers' purchase statistics and purchasing power (purchase frequency, wallet share, household penetration, household income etc.)

  • Channel preferences

  • Jobs-to-be-Done (JTBD) + Context (based on the segments)

    • Pains&Gains

      • Pain Relievers&Gain Creators (product elements and materials used, product features and functionality)

        • Products (Product Items) > Product Ranges/Options&SKUs > Collections/Product Lines

• Market Competition

  • Competitor analysis

  • Market positioning of competitors

  • Market competition characteristics

These inputs are important for the forecasting process as they reveal the growth&profit potential, obstacles and barriers in the market.

2. Gross Profit & Operating Profit

The gross profit forecast is based on the revenue expected to be earned from the products or business, and the COGS assumption. On the other hand, the operating profit is derived from the gross profit and operating expenses.

2.1. Sales Revenue

Sales Revenue Forecast = (Average Retail Sales Price) x (Numbers of Products Expected to Be Sold)

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Price Architecture Total Sales Quantity Forecast

Total Sales Quantity

The figures such as population sizes and personal/household disposable income levels of the target segments only show the theoretical potential of the market and cannot be used alone to determine sales volume (numbers of products expected to be sold). The measure of real potential is related to the size of the segment population intending to purchase the products. For intention/consideration, U&A research should be conducted on customer segments. If it is not possible, analysis of how the customers perceive our and competitors' value propositions (quality, value for money, personalization etc.), the comparison of competitors' price indices, and analysis of the customer segment's income and wallet share levels should be conducted.

The rate of sales ("cover" in Retail industry) assumptions made over the inventory level is the other important parameter to forecast the sales quantity.

Price Architecture

• Sales Price

  • Unit Supply Price: The unit supply price is the starting point to create a price architecture. The initial sales price is determined by setting a markup target over this base price. The unit supply price differs between supply markets due to such as manufacturing infrastructure and capacity, supply possibilities of raw materials&semifinished products, quality level, lead time, innovation-Research&Development (R&D) capability, FOB or landed costing model and tariff. The supply volume and plan (schedule), which are based on assumptions regarding monthly sales quantity, may also affect the supply price level in terms of economies of scale, minimum order quantity obligation of suppliers, seasonality etc. At the end of the day, the main point determining the supply costs is how the supply is distributed to which locations by product and raw material. This parameter is highly related to the capabilities and advantages of the supply markets.

  • Initial Sales Price: The initial pricing for a product is determined by considering the economic situation&conjuncture, product architecture, unit supply price, customers' purchasing power, competitor price indices (price comparison) and markup expectation.

  • Final Sales Price: The final price is the ‘real’ retail sales price on the label. By conducting a Price Elasticity research on target customer segments, it is determined what maximum price levels customers can accept. Subsequently, the initial price is adjusted to become the final price.

  • Average Sales Price: This parameter is calculated by averaging the unit sales prices of all products.

• The Rate of Sales Price Increase: Another factor influencing the price architecture is the rate of price increase. To determine it, exchange rate, wage&minimum wage increase, retail and producer inflation rates and competitor price indices should be forecasted.

• Product Discount Rate: The last parameter to be determined in the pricing process is the average discount rate expected to be applied in the fiscal year. The level of this parameter is determined by considering the customers’ interest in promotions and discounts, which can be influenced by changes in disposable income and household income, inflation, economic stabiliy and customers' trust on economy. Additionally, the competitors’ promotion and discount strategies and tactics in the market are taken into account when setting the discount rate.

The Rate of Sales Price Increase and Product Discount Rate will serve as inputs for the subsequent steps of the profit and loss (P&L) analysis.

Based on the ratios shown by all these analysis, a sales forecast is made.

2.2. COGS (Cost of Goods Sold)

The COGS is derived from average unit supply price and sales volume assumption. If different product mixes are expected to be sold in different channels (e.g. store, e-commerce, marketplace), COGSs should be differentiated on a channel basis.

3. Operating Expenses

This part seeks answers to this question: What levels of expenses are not directly incurred from the product (all expenses incurred in producing products or supplying products are included in COGS)? To define these expenses, the operating model should be examined: How will the products be developed, supplied, stored, promoted and sold? Some of expenses incurred from the operational activities like:

• R&D expenses

• Transport expenses of supplied products (depending on the supply costing model of suppliers: FOB or landed)

• Logistics&distribution expenses (caused by logistics network and operations)

  • Warehouse space - as expense shares of renting (m2), energy (m2) and personnel (man-hour)

  • Warehouse operations (handling, sorting, carrying, inspection etc.)

  • Material usage (warehouse pallet, parcel, shrink package-film etc.)

• Marketing&communication expenses

• Channel-based expenses (to sell the products)

• ...

All the expenses incurred by each operating item should be determined. The expenses arising from labour required to run the operations (norm staffing) and its development needs are forecasted in this section (efficiency and productivity analysis are important inputs). Marketing and communication expenses are determined through strategies on brand funnel management, communication through channels etc. The last item to be determined is general and administrative expenses.

In addition to operating expenses, CAPEX incurred from the investments required to launch the products or establish the business (such as brand-specific warehouse space, brand investment -brand logo design, trademark registration etc.), amortisation&depreciation of fixtures should also be determined, and business cases should be prepared for each investment option.

4. Financing Expenses&Tax

Financing expense (such as interest expenses) and tax assumptions should be made to determine the net profit level.

CHANNEL DOMAIN

The second domain of P&L is Channel domain. A channel is where products are delivered to the customers, and revenue is generated. Total revenue is generated in different portions across the company's channel mix.

Understanding the structure of business channels, or the channel mix through which products will be sold, is essential to forecast channel-based revenue and expenses. For this, answers to the following questions should be sought:

• How is the channel mix?

  • Offline Channels: Stores, department stores, corner shops, pop-up stores etc.

  • Online (E-commerce) Channels: Company's web site, landing pages on company's web site, brand-specific DotCom, online marketplaces etc.

  • Omnichannel (Channel Integration)

  • Other Channels: Wholesale, franchise, JV etc.

• How many channel points are planned to be opened under every channel type?

• What is the timetable for channel setups&go-live (on a Gantt chart as below)?

• How will the customer journey be in each channel? Touch points, customer experience, customer service design, channel operations, channel staff requirement etc.

An Example of Brand Roadmap

1. Gross Profit & Operating Profit by Channel

The gross profit and operating profit may differ from channel to channel due to variations in product mix and channel-specific operating expenses.

1.1. Sales Revenue by Channel

Channel-based sales revenue is derived from a formula as bellow:

Sales Revenue Forecast=(Average Sales Price)x(Numbers of Products Expected to Be Sold in Channel)

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Price Architecture Forecasted Sales Quantity (Channel-based)

Numbers of Products Expected to Be Sold in The Channel = (Traffic x Conversion Rate) x (Basket Size)

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Forecasted Number of Customers

(Channel-based)

Sales Quantity: To forecast the sales quantity, the following parameters should be analyzed:

• Territory/Region-based Market Potential: Population, socioeconomic status, customers’ channel preferences and penetration (additionally e-commerce penetration for e-commerce channel), competitors' market penetrations and number of stores per capita (territory-based) etc.

• Channel-based Inventory & Cover

• Forecasted Number of Customers: Traffic rate (foot count for offline channels), conversion rate (as a percentage of population intending to purchase)

• Basket Size

• Revenue Targets: Ambitions of top management

Product Capacity by Channel: How much capacity to be allocated for each product in each channel is determined based on:

• Sales Quantity Forecast

• Number of Channel Points Planned to Be Opened & Annual Opening Plan

• Total Store Area and Capacity (Total LCM - Annual Store Capacity Plan)

Average Sales Price: Since the average retail sales price is related to the product mix allocated to each channel, it may differ from one channel to another.

Basket Value: This parameter measures the sales value per e-commerce customer.

Terminal Inventory: The part of purchased inventory, which is not sold due to planning accuracy issues and transferred to the next term/season, is an important input to forecast the sales quantity in the next seasons. This will create an additional expense later on due to warehousing cost and financing expense, and will be able to cause a working capital deficit. It also results in a loss of product value.

In some channels such as department stores the revenue structure differs from the other channel types due to commission income.

1.2. COGS by Channel

The COGS may differ from channel to channel due to the different product mix.

1.3. Expenses by Channel

When you aim to generate revenue in a sales channel, you should be ready to meet the expenses incurred by that channel:

• In offline channels, expenses are incurred to run channel operations such as aisle management, inventory management, checkout, customer service, as well warehouse&logistics management, renting (space area, m2), in-store visual materials and decorations, in-store marketing ve communication activities.

• In online channels, expenses such as product category management, e-commerce warehouse&logistics management, shipping costs (due to free shipping campaigns as well as returns), value-added costs such as return pickup from home, product customization&personalization, sending personalized cards and gifts in packages occur.

• In omnichannel practices, various expenses such as Click&Collect operations and delivery by convenience stores are incurred to create a seamless customer experience.

The expenses incureed from personnel to run the channel operations (norm staffing) and these personnel's development needs are expense items with a high percentage. Additionally, headquarter expense shares (caused from central activities such as R&D, Information Technology, Human Resources Management, Risk Management, Auditing) should be calculated for each channel and included in the P&L.

Marketing and communication expenditures are required to position the brand in the market as well as to promote sales in a specific channel. Below is an example of how to determine digital margeting expenditures required to be budgeted (including digital performance marketing+digital communication budget) in order to create a targeted level of traffic and conversion rate (CR) on the website:

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Main Question: What digital marketing and communication investments should we make to bring targeted sales in e-commerce?

Organic (Unpaid) Marketing

Main and sub banner ads are often used to generate an organic traffic and improve the CR on a website. The required level of Click-through Rate (CTR) derived from banner impressions and clicks should be calculated against the CR target.

Digital Performance Marketing

Customer acquisition, traffic from search engines, display banner usage and affiliate marketing activities (as ways of paid/inorganic traffic generations) can be used to contribute the CR.

Digital Communication

Hero Content & Influencer Recommendation campaigns on social media can also drive inorganic traffic to the website.

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Also, various investments for offline channels such as store construction, concepts, fixtures; investments for online channels such as web site build, hosting, softwares, server are included in CAPEX.