What Is a Profit-and-Loss Statement?

Profit and loss statement template

If you have a bookkeeper or accountant, they may already generate P&L/income statements for you. Likewise, many types of accounting software will automatically generate useable income statements, so long as you accurately categorize all your transactions.

Want to take a DIY approach? Our expert bookkeeper

Want to take a DIY approach? Our expert bookkeepers here at Bench have built a profit and loss statement template in Excel. You can use it to turn your business’ financial information into a P&L statement.

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2. Cost of goods sold (COGS)

Next, businesses that sell goods must figure the cost of the goods they’ve sold. This should include any materials, transportation, or production-related expenses that your business pays before you can sell a product.

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What Does a Profit and Loss Statement Contain?

When preparing a profit and loss or income statement, there are a few main categories your financial report should cover. Below are some important sections to include in your profit and loss statement.

  1. Total revenue: Revenue (also called sales revenue or operating income) is the income that your company received from its normal business operations.
  2. Cost of goods sold: The cost of goods sold (also called COGS or cost of sales) is the direct cost of the goods or services that your company sells—for instance, the price your company pays to make the product it sells, including the raw material and labor costs.
  3. Itemized expenses: All income statements should have a detailed list of individual expenses—from rent; to selling, general, and administrative expenses (SG&A); to equipment and marketing expenses. Many companies will also include depreciation expenses in their total expenses, to show the cost of their fixed assets. Some companies separate their expenses into operating costs (internal day-to-day expenses that you have more control over) and non-operating expenses (like income taxes and interest expenses, which are external). Separating the expenses this way allows companies to calculate their operating profits.
  4. Net profit: Your company’s net profit (also called net sales or net earnings) is the gross profit minus expenses, and is the final line on your income statement. This is the numeric indicator of how your company profited or lost during a specific period of time, whether you’re compiling a monthly, quarterly, or annual income statement.
  5. Gross profit: Gross profit is your total revenue minus your COGS—in other words, it’s how much your company would have made if it incurred absolutely no other expenses. Gross profit isn’t necessary to list on an income statement, but it’s a great way to put your expenses in perspective.

How a Profit and Loss Statement Works

As you move through income and expenses step by step, the story behind profitability (or losses) unfolds. The income statement starts with revenue and moves on to expenses that eventually result in the organization’s profit or loss.

Some P&L statements include a company’s earnings per share (EPS).

If any parts or materials are required, those costs typically go under cost of goods sold (COGS). The result is gross profit. Next, the statement subtracts any expenses necessary to run the business, such as payroll, utilities, maintenance costs, and other expenses. The result is operating profit. At this stage, you can tell how effective the company is at providing goods or services at a profit.

In addition to understanding the ability to operate at a profit, it’s crucial to know what the bottom line is after all taxes and interest costs. If an organization borrows money, excessive interest costs can wipe out any profits. By examining interest expenses, you can evaluate if companies are using debt wisely. Plus, taxes are a reality for many businesses, so you need to know how much after-tax profit remains after paying all necessary costs. 

After subtracting everything—including input costs, operating expenses, financing costs, and taxes—you arrive at the net income.

Analyzing Profit and Loss Statements Over Time

A P&L statement is a snapshot of one period’s financial results. But that information might not be useful unless you understand the bigger picture. By reviewing how the P&L statement changes over time, you may be able to spot trends. For example, if COGS increases dramatically, that may indicate less profitability ahead (or just a temporary spike in input prices). Thus, it’s essential to view each P&L statement as one piece of the puzzle.

PL example

Let’s take the case of a part-time home-based specialty cake-maker. His revenue for the year is $5,000. His COGS (flour, eggs, etc.) is $800. His other expenses include boxes for the cakes, car expenses to deliver the cakes, advertising, and insurance. His P&L for the year ending 12/31/XX would be as follows:

Revenue = $5,000

COGS = $800

Gross profit = $4,200

Expenses

Boxes = $100

Car = $400

Advertising = $800

Insurance = $1,200

Total = $2,500

EBIDTA = $1,700

Taxes (no loans or depreciation/amortization of assets) = $375

NET PROFIT = $1,325

You can use this P&L example to see the net profit margin. Divide net profit by revenue. In this example, the net profit margin is 26.5 percent ([$1,325 ÷ $5,000] x 100).

If this baker has a P&L for the prior year, he can compare his business performance to see whether sales are growing year over year, expenses are lower than in previous periods, or there are other changes that indicate he must do things differently.

Deeper definition

A profit and loss statement shows how a business turns revenue into profits, helping managers gauge the ebb and flow of earnings and expenditures. Creditors and investors consult a P&L to determine the level of risk involved in joining a venture or extending capital to a business. The statement also registers gains and losses to be taxed or credited for Internal Revenue Service (IRS) purposes.

Public companies are required to produce three foundational financial statements quarterly and annually for public disclosure: a profit and loss statement, a balance sheet, and a cash flow statement. Private companies create profit and loss statements on a regular basis for internal management purposes and for their investors.

There are two accounting methods for building a profit and loss statement. Under the simple single-step method, a business totals revenues and subtracts expenses to get the bottom line. With the more complicated multi-step approach, you begin by deducting operating expenses from revenue, which yields operating income. Operating income is added to the net of non-operating revenues, non-operating expenses, and investment gains or losses, leaving you with pre-tax income. After deducting income taxes, you have net income.

Benefits of a profit and loss statement

There are many benefits of preparing and referring to a profit and loss statement, including:

●     Get a snapshot of your company’s current profit for a period: With a profit and loss statement, you can immediately see if your company is generating a profit. While determining expenses, search for ways to lower your company’s costs or increase its revenue.

●     Compare your current profit and loss to past financial periods: Is your company growing? Are you increasing profits? If so, how quickly? It’s helpful to compare your current and past profit and loss statements to see where you can improve.

●     Attract investors: New and existing investors will want to see periodic profit and loss statements to know how your company is performing financially.

●     Prep for financing: If you apply for a business loan or want to finance new equipment, a bank will likely ask to review your profit and loss statement.

You can ask your accountant to prepare a profit and loss statement for your company or you can build one yourself using the steps below.

Why a Profit and Loss Statement is So Important for a Small Business

This accounting concept looks at business income for a specific period. P l statements are critical for other reasons too. Following are a few of the reasons you need these statements.

For Making Good Decisions

These compare a small business” total expenses against total revenue to make decisions based on real numbers. There’s no guesswork when you use these.

For Attracting Investors

Show off your financial strength over a specific time period. A great idea for any public company looking to attract investors.

Great for a startup looking to do the same.

For Forecasting Expenses

A good business model looks at more than just a company’s revenues. Rent, salaries, and other expenses like equipment purchases need to be considered. P l statements help forecast these on an annual basis.

For Projecting Revenue

Business finances look at top-line revenue statement numbers too. A company’s ability to generate revenue is in a profit/loss statement p l.

For Getting Taxes Ready

Updating this kind of income statement keeps you ready for tax time.

How to read a profit and loss statement

Reviewing revenues and expenses by line item and comparing amounts to prior periods helps identify positive or negative trends in the business. To begin, it’s important to know the company’s accounting method: whether it reports on the cash basis (which generally means income is reported when received and expenses reported when paid) or accrual basis (which generally means income and expenses are reported when all the events needed to fix the amount have occurred with reasonable certainty). The accounting method affects how income and expenses are taken into account on the P&L. Once you know this, you can begin to look at the line-by-line entries on the P&L.

Key components of a profit and loss statement for small businesses

The P&L is comprised of two main parts: the income earned during the period of the statement and the expenses in the same period. These two parts are broken down in the various entries relevant to your business. Not every P&L will have the same lines.

1. Revenue

Revenue is reported first on a profit and loss statement for small businesses and includes all income items. This entry on the P&L may be referred to as sales, gross receipts, fees, or any other term to describe the company’s operating revenue. Operating revenue is typically broken out from non-operating sources of income, like interest.

Again, the accounting method affects when revenue is reported on the P&L. When using the accrual method of accounting, revenue is reported when earned, at the time of sale, even if payments have not yet been received. If the cash method is used, revenues will be recorded when payment is received. To increase the accuracy of reported income, gross sales may be adjusted based on past experience of customer returns or refund requests by setting up an allowance and netting it against revenues.

2. Cost of goods sold (COGS)

A company that sells goods must figure the cost of goods sold (COGS). This is essentially the cost of inventory or materials used to create products, which is then subtracted from the sales to determine the actual revenue (gross profit) from the sales. For example, a company that carries a $20 item in inventory and sells it for $100 would have $100 in revenue, but after taking the $20 of COGS into account would report $80 in gross profit.

3. Expenses

The expense portion of a profit and loss statement for small businesses encompasses any expenditure made to operate the business. These can include:

  • Advertising costs
  • Employee salaries, benefits, and payroll taxes
  • Interest expenses
  • Office supplies
  • Payments to vendors or contractors
  • Professional fees for accountants, attorneys, etc.

Accounting for some expenses requires understanding asset depreciation. Some purchases, such as office equipment, must be capitalized as an asset and written off over the useful life of the item. For example, if a $1,000 computer is purchased (and no accelerated write-off is used to account for the purchase for tax purposes), it would be reported over five years. Each year the profit and loss statement reflects 20 percent of the cost for the computer, or $200 in expense.

Non-operating expenses, such as interest and taxes, are often broken out separately from operating expenses for illustrative purposes.

4. Gross profit

Gross profit is the difference between the revenue or gross receipts and the cost of goods sold. If the company is a service business without inventory, then the gross profit and the gross receipts are the same amount.

5. Net profit or loss

After calculating any taxes due and subtracting them from pretax income, the net amount will equal a company’s profit or loss for the period. When trying to compare companies in different industries and tax situations, or if exact numbers aren’t yet available, net profit or loss is often equated to the earnings before interest, taxes, depreciation, and amortization (EBITDA).

Examples of P&L statement analysis

A quick glance at a P&L shows whether the company is making or losing money. But delving deeper can reveal much more. This is important when creating a comparative income statement, whether comparing a single business’s performance over multiple accounting periods or comparing one company’s performance to another (something an investor would do).

There are different ways to analyze a P&L:

Horizontal analysis

This type of analysis is also referred to as series analysis. It looks at changes over time within a particular line item. For example, figure the percentage that revenue increases year over year for a five-year period. It helps you see patterns, such as cyclical occurrences. It helps you detect red flags (e.g., that COGS is too high).

Vertical analysis

Vertical analysis, also referred to as common-size analysis, looks at the relative size of expense items to the company’s revenue. For example, how much is a company spending on marketing or research relative to its revenue, and how is this trending over time?

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