What Is a Profit and Loss Statement?

By Indeed Editorial Team

Updated February 23, 2021 | Published February 4, 2020

Updated February 23, 2021

Published February 4, 2020

The profit and loss statement is one of the most instrumental financial statements of any company. Whether you're using spreadsheets or accounting software to create your profit and loss statement, it is essential to learn about its different components. When you do, you can use this statement to improve your business's efficiency. In this article, we will explain what a profit and loss statement is and how to compose one yourself.

What is a profit and loss statement?

The profit and loss (P&L) statement outlines a company's revenues, costs and expenses over a specified period. Accountants generally assess the P&L at the end of a fiscal year or a quarter. These records display a company's ability to generate profit. It helps the business owners and managers determine if they should increase revenue, decrease costs or both in order to improve their results.

Some call the P&L statement by other names, such as an income statement, statement of profit and loss, statement of financial results or income, expense statement, statement of operations or earnings statement. Along with your balance sheet and statement of cash flows, you can use a profit and loss statement to take a detailed and comprehensive look at your company's financial situation and performance.

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Understanding the profit and loss statement

The information a P&L statement presents might seem unfamiliar at first sight. To understand what is in the income statement, you can start by learning about the most common terms and their definitions:

  • Net income: The net income is the "bottom line" on a profit and loss statement. It is the result of your total revenue minus all your expenses. It can be a profit if it shows a positive amount or a loss if the amount is negative. Although not ideal, there are times when a loss will occur, especially when you first start your business. The net income is the most important line on your profit and loss statement.

  • Revenue: Your revenue includes the money earned by making sales, selling equipment and properties and receiving tax refunds.

  • Expenditures: This refers to the money your business spends. Only some types of spending are included in this line.

  • Cost of goods sold (COGS): This is the cost of producing and selling a product or providing a service. It includes the materials, labor cost and time it takes to complete necessary tasks.

  • Gross profit: Gross profit is the result of your revenue minus the cost of goods sold.

  • Operating expenses (OPEX): Operating expenses are the costs associated with running your business that are not included in the cost of goods sold. For example, this can include advertising, utilities, rent, vehicle expenses, office supplies, hardware and software, travel, meals, entertainment, training, building leases, equipment purchase or rental, bank charges, licenses, permits and cellphones and internet service. These expenses depend on the size and type of business you run.

  • Depreciation: Depreciation shows the value loss that business goods like equipment, cars or machinery endure over time. You can deduct it as a loss in tax declarations.

  • EBIT: Also called operating profit, the acronym EBIT stands for earnings before interest and tax. You can obtain this number by deducting operating expenses from the gross profit.

  • EBT: Earnings before tax refers to the total revenue minus OPEX, COGS, interest, depreciation and amortization from your total income. EBT is an indicator of business performance. You can use it to compare your business to others.

  • Earnings available for common shareholders: This line is important in case your company has investors or if you take a salary from the company. It shows the net after-tax profit, subtracting any dividends for preferred shareholders.

  • Owner's draw: This is the business owner's salary, coming out of company revenues.

What to include in a profit and loss statement

You can use the same process to prepare your profit and loss statement whether you do it for business analysis or tax preparation. Here is what you will need to include on the P&L and how you should incorporate it in order to make accurate calculations:

  1. In your first section, write down your business income (also called sales) for each quarter of the year. You can split your income into different sub-sections if it comes from various sources.

  2. Just below, write down your total cost of goods sold.

  3. Then, list your quarterly operating expenses. You can also note each expense as a percentage of income in a separate column, totaling 100% of income/sales.

  4. Next, calculate the difference between your income and your expenses and write the result on the 'earnings' line, or EBITDA (earnings before interest, taxes, depreciation, amortization).

  5. After that, take the total business interest charges for the year and subtract them from your EBITDA.

  6. Next, subtract taxes from your EBITDA. You can estimate your tax amount by applying the tax percentage to your total income.

  7. If applicable, subtract the total depreciation and amortization for the period.

The number you have on your bottom line shows your business's profit or loss. From there, you can plan a course of action to improve your business's efficiency.

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Example profit and loss statement

Here is an example of a profit and loss statement for a company that sells products online and in a store:

Income

In-store sales$20,000Online sales$45,000Other income$5,000TOTAL INCOME**$70,000Cost of goods sold($20,000)GROSS PROFIT**$50,000Operating expenses
Payroll($6,000)Travels, meals, entertainment($500)Licenses, permits($130)Rent($5000)Bank charges($200)Equipment($300)Insurance($400)Credit/Debit card fees($70)TOTAL OPERATING EXPENSES($12,600)EBITDA**$37,400Interest charges($1000)EBT**$36,400Taxes (assuming 20% taxes)($22,400)Owner's draw($2,000)NET INCOME**$12,000**This company makes a profit of $12,000. Most of its revenue comes from online store sales, and its most significant operating expense is payroll. As business owners look at these numbers, they might want to expand their online business to maximize their profit.

It is essential to have correct numbers in the P&L. Therefore, the role of the accountant in inputting values in the accounting system is crucial.

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How to prepare a projected profit and loss statement or pro forma

If you are starting a new company and don't have the necessary information to prepare a profit and loss statement, you will need to develop a pro forma statement where you estimate your revenue and expenses for each month of your first year in business. This is a document that your bank or investor might ask you for before lending you funds. The projection you will present in the pro forma statement will demonstrate when your business will reach the break-even point and start to generate profit.

Here are the steps you will need to take in order to develop your pro forma statement:

  1. Start by listing all your possible expenses and overestimate them.

  2. Write down your projected sales. Underestimate the amount you think you will gain.

  3. Calculate the difference between revenue and expenses. Your results may be negative for the first few months. Add them together to get an idea of the amount of money you will need to borrow to start your business.

Why is the P&L important?

The profit and loss statement is important because it efficiently shows the amount of profit or loss a business has generated over a period of time. Therefore, it is one of the most popular financial statements. Every public company has an obligation to issue its P&L quarterly and annually, along with the cash flow statement and the balance sheet.

For small businesses, the income statement is the opportunity to review your net income to help you make effective business decisions. It is essential that you read your P&L regularly and compare it to past statements. That way, you can always make informed decisions on how to drive profit into your company.

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