Profit and Loss Statement: Definition, Examples & How To Do One

Are you making or losing money? You need to track your financial progress by reviewing a profit and loss statement to know how your business is doing. This will let you see whether you're on track for profitability and growth or losing money and need to make changes.

Here, we'll walk you through how to create a profit and loss statement (P&L), explain how to read a profit and loss statement, and provide a P&L example as an easy-to-follow guide.

Familiarizing yourself with these fundamental practices is crucial to getting your business on the path to profitability.

What Is a Profit and Loss Statement?

A profit and loss statement is a financial statement businesses use to outline income and expenses over a specific period. It is also called an income statement, statement of profit, statement of operations, or a profit and loss report. Typically, organizations prepare a P&L at least quarterly and annually, but it can be done more frequently.

Income Statement vs. Profit and Loss: Are They the Same?

An income statement and a profit and loss statement are two names for the same financial report. There's no difference between the income statement vs. P&L. This report may also be called a statement of operations, statement of financial results, earnings statement, expense statement, or operating statement. It gives stakeholders a clear understanding of the business's financial performance and whether it is generating a profit or incurring a loss.

Balance Sheet vs. Profit and Loss Statement

A P&L is not the only financial statement essential to understanding how your business is performing. Balance sheets are also vital. They list the company's assets, liabilities, and the owner's equity as of a set date (e.g., December 31). They show whether a company is too leveraged (i.e., has too much debt).

A balance sheet is helpful when maintaining a cash flow statement, which details the money going in and out of the company. Balance sheets show whether the company has sufficient funds to pay bills when they come due.

Of all these financial statements, the P&L is considered to be the most important because it shows a business's ability to make a profit.

Preparing the P&L and any other financial statement is pretty straightforward. If the company has an accounting system, it can track revenues, expenses, assets, and other key numbers as they occur and generate these reports at the touch of a button.

How Often Are Profit and Loss Statements Calculated?

Typically, businesses prepare profit and loss statements monthly, quarterly, or annually (quarterly and annual statements are recommended). When applying for a small business loan, companies must often produce several years of profit and loss history, if available.

Similarly, when a company seeks investors or a business owner wants to sell, interested parties want to see P&Ls for a number of years to detect the direction in which the organization is moving.

For tax law purposes, generating and submitting a P&L to the IRS is not required. However, the tax return itself is the P&L, reflecting the company's income and expenses for the year.

There are differences between the P&L and the tax return because not all expenses are deductible on the return (e.g., only 50% of business meals are deductible on the tax return, while 100% of these expenses are reductions on the P&L).

Types of Profit and Loss Statements

P&L statements come in several different types, depending on the complexity of the business and the level of detail required. The method you choose affects how the information is presented and the insights that can be gained from the statement. Understanding the various types of profit and loss statements will help you choose the proper one for your company's needs.

Single-Step Method

The single-step method is the simplest way to create a P&L statement. With this approach, you list all revenue items at the top of the statement and subtract all expenses to arrive at the net income or loss. It requires only a single calculation.

Small businesses with uncomplicated financial structures are best suited for the single-step method. It provides a quick and easy way to assess profitability without breaking down the information into multiple categories. However, analyzing profitability is more difficult because the single-step P&L lacks detail.

Multistep Method

The multistep method is a more complex process. It involves categorizing revenues and expenses into operating and non-operating items, allowing for a more detailed analysis of the business's financial performance. It has 3 different calculations:

• Gross profit = Net sales - Cost of goods sold
• Operating income = Gross profit - Operating expenses
• Net income = Operating income + Non-operating items

The additional information breakdown makes the multistep method ideal for larger businesses or companies with more complex financial structures. It provides a more comprehensive view of the company's profitability and helps identify areas for improvement.

Cash Method

Preparing a P&L using the cash method bases calculations on the actual cash inflows and outflows of the business. This process recognizes revenue when cash is received, and expenses are recorded when money is paid out.

It's a straightforward option often preferred by small businesses and sole proprietorships. However, the cash method doesn't always provide an accurate picture of profitability since it doesn't account for revenue earned or expenses incurred but not yet paid.

Accrual Method

The accrual method of preparing a profit and loss statement focuses on when revenue is earned and expenses are incurred rather than when cash is exchanged. Under this method, revenue is recorded when a sale is made or a service is provided, even if payment has not yet been received. Similarly, expenses are recorded when incurred, even if the bill has not been paid.

When considering the cash method vs. accrual method, larger businesses tend to favor the accrual method because it offers deeper insight into a company's financial health.

How To Read and Analyze a Profit and Loss Statement

To effectively read and analyze a profit and loss statement, it's crucial to examine revenues and expenses line by line and compare the figures to previous periods. This helps identify business trends, whether positive or negative.

First, you must determine the company's accounting method: cash basis (income is reported when received and expenses are reported when paid) or accrual basis (income and expenses are reported when a transaction occurs, even if cash hasn't been exchanged).

The accounting method affects how income and expenses are accounted for on the P&L. Once you know this, you can look at the line-by-line entries on the P&L.

Key Components of a Profit and Loss Statement

The P&L comprises 2 main parts: the income earned during the statement period and the expenses in the same period. These 2 parts are divided into 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 and includes all income items. This entry on the P&L may be called sales, gross receipts, fees, or any other term describing the company's operating revenue. Operating revenue is typically separated from non-operating sources of income, like interest.

Again, the accounting method affects when revenue is reported on the P&L. 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 (subtracting) it against revenues.

2. Cost of Goods Sold (COGS)

A company that sells goods must figure the cost of goods sold (COGS). This is 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 report $80 in gross profit after accounting for the $20 of COGS.

3. Expenses

The expense portion of a profit and loss statement for large and small businesses encompasses any expenditure to operate the company. 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 5 years. Each year, the profit and loss statement reflects 20 percent of the cost of the computer, or $200 in expenses.

Non-operating expenses, such as interest and taxes, are often separated from operating expenses to illustrate the difference between the two.

4. Gross Profit

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

5. Net Profit or Loss

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

Analyzing a P&L Statement

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, also known as series analysis, looks at changes over time within a particular line item. For example, to calculate the percentage that revenue increases year-over-year for 5 years. Horizontal analysis helps you see patterns, such as cyclical occurrences, and detect red flags (e.g., that COGS is too high).
• Vertical analysis, also known as common-size analysis, focuses on the relative size of expense items compared to a 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?

How To Create a Profit and Loss Statement

Creating a P&L can be as simple as pressing a button if you regularly and accurately record your income and expenses in your accounting system. The accounting system generates your P&L on command.

If you want to create a P&L manually, the process is slightly more involved and time-consuming. To simplify the task, you can use a template. Here's a general step-by-step guide to creating a profit and loss statement:

1. Choose a reporting period. P&L statements provide a financial snapshot during a particular period, such as monthly, quarterly, or annually.

2. Gather financial statements and information. Locate necessary details on revenue and expenses, which can be derived from invoices, receipts, credit card statements, and bank account transactions.

3. Add up revenue. List your sales to determine your gross revenue. You can break it down into subcategories of sales if necessary or helpful for your business.

4. List your COGS. Determine your total COGS and subtract it from the gross revenue you calculated in Step 2. This amount is your gross profit.

5. Record your expenses. Create categories for each type of expense. Remember: don't include interest on company debt here; you'll account for it later.

6. Figure your EBITDA. Subtract the total expenses (from Step 5) from your gross profit (Step 4). This is your earnings before interest, taxes, depreciation, and amortization (EBITDA).

7. Calculate interest, taxes, depreciation, and amortization. List any interest you may have on business debt, taxes on net income (usually estimated since a P&L is likely being prepared before filing a return), and depreciation and amortization expenses.

8. Determine net income. Subtract the interest, taxes, depreciation, and amortization (Step 7) from EBITDA (Step 6).

After completing these steps, you'll have the information to complete your P&L.

Profit and Loss Statement Example

Let's take the case of a part-time home-based specialty cake maker to create a P&L statement example. 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 12/31/23 would be as follows:

Even with this simple P&L example, you can analyze the financial information to determine the net profit margin. To calculate it, you'll divide net profit ($1,325) by revenue ($5,000). In this example, the net profit margin is 26.5 percent.

If this baker has a P&L for the prior year, he can compare performance to see if sales have grown, expenses have declined, or if anything has changed to indicate he needs to change his business strategy.

Importance of Profit and Loss Statement

A profit and loss statement is a crucial financial document for any business. It provides a clear and concise snapshot of the company's financial performance over a specific period. By summarizing revenue, expenses, and, ultimately, profitability, a P&L statement offers valuable insights into a business's health and viability.

Understanding your financial statements, such as the P&L statement, is essential for pinpointing potential improvements, such as curbing expenses or channeling focus towards more lucrative products or services. Additionally, the importance of a profit and loss statement goes beyond internal use—it's often required by investors, lenders, and other stakeholders when assessing a business's financial stability and growth potential.

P&L Statements Are the Bottom Line in Business Finance

Small businesses often have their attention keenly focused on the bottom line. To ensure you have a firm grip on your business finances, consistently maintain and review your P&L statement. Use expense management tools to improve your P&L and steer your company toward sustained profitability and financial health.