Growing your business means understanding where it is financially and keeping it solvent. To do that, you must know how much you are making and how much you are losing. A Profit and Loss Statement (P&L) breaks down your profit and loss so you can determine your net income and make the right decisions about future business opportunities. With that in mind, let’s dive into what the P&L is and how you can create one for your business.
What is a Profit and Loss Statement (P&L)?
A P&L statement gives you a close look at your total profits, liabilities, and expenses by breaking down your profit and loss line by line for a specific period, which could be a month, a quarter, or a fiscal year. They are presented on either a cash or accrual basis. With the information provided, investors, lenders, and the leadership of a company can analyze its financial health. Many companies incorporate the P&L into their business plan, as it shows how much profit or loss was generated.
What Are the Benefits of A Profit and Loss Statement?
Simply put, it is a straightforward way to summarize expenses and income over a period of time but also allows you to compare these areas across multiple periods, thus understanding trends and patterns. You also can discover where your business might be struggling, as well as track improvements when you make adjustments to determine if those adjustments are working. Many companies also utilize their P&L to develop sales targets, craft budgets, and pricing for their products or services.
As a small business owner, you likely are interested in what your own P&L statement has to say about the financial state of your company. Your company’s accounting software might offer you the ability to create your financial statements with a few clicks of your mouse, but it is important to know what data comprises the P&L statement. Let’s follow the steps that are part of creating your own P&L statement.
How to Make a Profit and Loss Statement
Step 1: Determine your company’s revenue.
To determine your company’s revenue, you need to know what it entails. Revenue is generally the value of all sales of goods and services recognized by a company during a specific period. It also makes up the top line of your P&L statement. Expenses will then be deducted from this number to provide profit or net income.
When goods or services are sold on credit, then they are recorded as revenue, even if the cash payment has not yet been received. Its value is also recorded on your balance sheet as the accounts receivable. When the payment is received, no additional income will be recovered, but your cash balance will go up as your accounts receivable goes down.
Your revenue formula can be simple or complicated, depending upon the business. Product sales, for example, are calculated by taking the average price at which your goods are sold and then multiplying it by the total number of goods sold. Service companies calculate the value of all their service contracts or the number of customers multiplied by the average price of your services. These formulas can be expanded for more detail, including revenue forecasts all the way down to individual product or customer levels.
Step 2: Calculate your company’s cost of goods sold.
Calculating the costs of goods sold (COGS) helps you to know how much cash it takes to make your products. This calculation should include any materials and direct labor costs that contribute to production. It should also incorporate the overhead costs, such as utilities or rent. COGS calculations are based upon the products actually sold but do not include inventory on hand. To calculate your COGS, you will need to include both direct and indirect costs.
Direct costs include:
- Materials
- Parts
- Labor
Indirect costs include:
- Equipment
- Facilities
- Rent
- Other expenses involved in production and shipping
- Labor costs related to shipping
Then you determine how much of your beginning inventory is finished product, raw materials, and products in progress that you have at the start of your accounting period. Additionally, you will need to add the total costs of each product you add to your inventory throughout the year, as well as any additional labor costs. Then determine your ending inventory, including subtracting any inventory that was unable to be sold due to defects, damage, or theft. You should also note an updated value for any outdated inventory. The formula would be the following:
Beginning inventory + new purchases – ending inventory = cost of goods sold
Knowing your COGS can assist you in determining profitability, measuring your manufacturing and operational efficiency, and bringing awareness of potential problems. If the COGS are so high that you cannot sell your product for a profit, then you may need to reduce your COGS or reevaluate your product strategy altogether.
Once you have your COGS calculation completed, subtract that amount from your revenue on your P&L statement.
Step 3: Calculate your company’s gross profit/loss.
Gross profit is what your company makes after deducting the costs associated with making and selling your products or the costs associated with providing your services.
The formula for gross profit is:
Net sales – COGS = Gross Profit
Net sales are equivalent to revenue or the total amount of cash generated for a specific period and can include discounts and deductions for returned merchandise.
Step 4: Determine your company’s operating expenses.
Operating expenses are the selling, general, and administrative expenses that don’t relate to the production of any product. Note that operating expenses can greatly impact the profitability of your business over time.
If you want to improve your company’s bottom line, reducing operating expenses may be your best option without impacting the price or quality of your current line of products and services.
Here are a few examples of operating expenses:
- Accounting fees
- Advertising and marketing
- Insurance
- Legal fees
- Office supplies
- Maintenance and repairs
- Salaries and wages (other than direct labor for production employees)
- Property taxes
- Travel
- Utilities
- Vehicle expenses
Once you have your operating expenses, then you want to subtract them from your revenue as well.
Step 5: Calculate your company’s operating profit/loss
Your company’s operating profit is its total earnings from the core business functions for a specific period. It excludes any profits earned from ancillary investments, including businesses the company has a partial interest in. Operating losses, on the other hand, occur when core business income is lower than your expenses.
When you calculate operating profit, you eliminate several indirect factors that can end up obscuring the true performance of your company. Additionally, as you complete these calculations, you can find your operating profit margin, which will show you how well your company is doing at turning gross revenue into profit. The formula for operating profit/loss is:
Operating profit/loss = Gross Profit – Operating expenses – Depreciation – Amortization
This operating profit calculation is also referred to as earnings before interest and tax (EBIT). You can opt to present your operating profit in place of net income on your P&L statement.
Step 6: Determine any other income, other expenses, interest income, and interest expense.
Working with your bookkeeper, you can easily find all the additional forms of income or expenses that still need to be subtracted or added to your P&L statement.
Step 7: Calculate your company’s income tax expense.
To calculate your company’s income tax, you need to identify all your taxable income first. Then follow these steps:
- Find the sum of all these taxable income streams.
- Determine your tax rate.
- Apply the income tax expense formula (Income tax expense = Taxable income * Tax rate).
- List income tax expenses on your P&L statement.
Taxable income is often complex and layered, so working with your accountant can help you to be sure that it has all been included in your P&L statement. Your income tax expense is the amount of money that you estimate your company will owe on taxable income.
Step 8: Calculate your company’s net profit/loss.
After completing all these steps, your P&L statement should have your net profit/loss, which is the amount of funds left after all expenses have been paid. If your business does not make enough to cover all your expenses, then you will be operating at a loss.
What You Can Learn from a Profit and Loss Statement
Fundamentally, your P&L statement is a clear way for your leadership to determine the financial health of your business. It also provides a clear snapshot of your expenses at various points throughout the fiscal year, allowing you to make decisions that can address unhealthy trends and keep your business in the best financial health possible.
Frequently Asked Questions
Why is a profit and loss statement important for my small business?
It gives you a clear picture of your financial situation and can be completed monthly to help you manage your cash and budget successfully.
How often should I prepare a profit and loss statement?
It can be prepared every month, quarterly, or annually. You can use these P&L statements to analyze your finances and make strategic decisions.
What information should be included in a profit and loss statement?
All income sources, COGS, and operating expenses.
How can I use my profit and loss statement to make informed business decisions?
You can compare P&L statements month to month, thus making it easier to identify trends and address problem areas.
How can I ensure the accuracy and reliability of my profit and loss statement?
Working with a bookkeeper, you can be sure that your transactions are recorded timely and accurately to keep your financials updated and reliable.
What Is AccountsBalance?
AccountsBalance is a monthly bookkeeping service specialized for agencies & SAAS companies.
We take monthly bookkeeping off your plate and deliver you your financial statements by the 15th or 20th of each month.
You’ll have your Profit and Loss Statement, Balance Sheet, and Cash Flow Statement ready for analysis each month so you and your business partners can make better business decisions.
Interested in learning more? Schedule a call with our CEO, Nathan Hirsch.
And here’s some free resources:
In Summary
As a business owner, accurate P&L statements are key to making the best financial decisions and assessing your overall financial health. To have the best P&L statement, it is critical that your bookkeeper manages your transactions, keeping your financial data updated and accurate. Following these steps can give you the best financial picture of your business at every stage of its growth.
