Building a business takes time and effort, but it also requires that you have a complete understanding of your financial position. After all, if you do not understand the status of your financial health, then you can put your business at risk by taking on expansions or opportunities that you can’t really afford. To make the best strategic decisions for your business, it is essential that you regularly review your financial statements, particularly your profit and loss statement. Let’s learn what it tells you about your business, look at some profit and loss statement examples, and learn how you can use it to successfully manage your company through various transitions.
What is a Profit and Loss Statement?
A profit and loss statement gives you a snapshot of 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.
Components of a Profit and Loss Statement
Your P&L will include three basic elements: revenue, expenses, and net income. When your P&L becomes more advanced, reflecting the expansion of your business, then it can also incorporate your operating profit and earnings before interest, taxes, depreciation, and amortization. Here are the following areas you should see on every P&L statement:
- Gross revenue – the amount of money received as payment for products or services
- Cost of Goods Sold (COGS) – expenses for everything involved in creating your product or service, such as manufacturing materials, contractors, and labor. However, it doesn’t include your operating expenses.
- Net revenue – the gross revenue minus your COGS, otherwise known as your gross profit or gross income.
- Expenses – any fixed or operating expenses required to run your company, including salaried employees, advertising, marketing, utilities, rent, and insurance.
- Net profit – also called net income, this is the net revenue minus the total expenses. If this calculation is negative, then it is called a net loss.
The beauty of a P&L statement is that it can be modified to highlight different information, allowing you to dig down further into your business beyond the expenses and revenue. Let’s talk about the different types of profit and loss statements, as well as what they can tell you about your company.
Types of Profit and Loss Statements
There are two main methods of accounting for P&L statements, which can assist you in the analysis of your company’s financial health.
Cash Method
Under the cash method, revenues and expenses are recorded when cash is received or paid out, respectively. This method is simpler and easier to implement but may not provide an accurate picture of a company’s financial performance as it does not account for transactions that have not yet been paid or received.
Accrual Method
Under the accrual method, revenues and expenses are recorded when they are earned or incurred, regardless of whether cash has been received or paid out. This method provides a more accurate picture of a company’s financial performance as it accounts for all transactions that have occurred during a specific period, even if they have not been paid or received yet. This is the method that is generally preferred by most professional accounting organizations, because it provides a more accurate picture of your company’s financial performance.
How to Calculate a Profit and Loss Statement
The different types of P&L statements are based on specific formats in which they can be presented. The two most common are the single-step and multi-step P&L statements, which can present your financial information fairly simply or with more detail, depending on what you want to drill down on in your financial analysis.
Single-Step P&L Calculation
The single-step P&L statement is a simple format that lists all revenues and gains together and all expenses and losses together. The net income or loss is calculated by subtracting total expenses from total revenues.
Multi-Step P&L Calculation
The multi-step P&L statement, on the other hand, is more detailed, separating operating revenues and expenses from non-operating revenues and expenses. It also includes gross profit, which is calculated by subtracting costs of goods sold from net sales. The net income or loss is calculated by subtracting total expenses from gross profit.
5 Profit and Loss Statement examples
There are several different profit and loss statement examples based on different industries. The real estate agent’s P&L statement includes revenue based on commissions, which is a service-based profit & loss statement. Another one of the profit and loss statement examples is a budget P&L statement, which helps you outline your expected income and expenses for the upcoming year. The average restaurant’s P&L statement highlights the unique aspects of the hospitality industry, including the costs of ingredients. A small business P&L focused on manufacturing will include the costs associated with finished goods and works in progress. A construction P&L statement includes lines for construction projects in progress, those booked but not yet begun, and completed projects. The beauty of P&L statements is they can be adapted to include the expenses and revenue sources that are unique to your business.
How to Analyze P&L Statements
Once you’ve put together your profit and loss statement, it’s useful to analyze it. It’ll show whether you’re profitable or not. But your P&L statement also allows you to identify where you can save or reduce spending. To determine profitability, you can use one of two common measures of profitability; gross profit margin and net profit margin. The gross profit margin is gross profit divided by revenue, which shows how profitable your business is at making products and services. The net profit margin is net income divided by revenue and shows what percentage of revenue you’ll keep after all the expenses.
Many small businesses aim for a net profit margin of 10%, although this will depend on your industry. Other key financial ratios are the accounts receivable turnover ratio, which shows how well you are managing your accounts receivable, and the inventory turnover ratio, which demonstrates how well you are managing your inventory.
Frequently Asked Questions
What is a Common Size Profit and Loss Statement?
A common size financial statement displays line items as a percentage of one common figure. Creating a common size profit and loss statement makes it easier to compare a company with its peers and analyze a company over time. All three primary financial statements can be put into the common size format.
What are the most important financial statements?
The three most important financial statements are the income statement, balance sheet, and cash flow statement.
What is an Income Statement?
The income statement is a more comprehensive version of the P&L statement.
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
The profit and loss statement is a critical part of your financial statements, assisting you in analyzing the health of your business. Determining whether you can take advantage of an opportunity or expansion should be based on accurate data, which is provided by your P&L statement. To make sure your financial statements are accurate, you need to work with a quality bookkeeper who understands the needs of your business and can assist with your analysis on a monthly basis. Doing so will help you to make the best long-term strategic decisions for your company.
