How to Read and Analyze a Profit and Loss (P and L) Statement

  • Accracy
  • 26th Nov, 2023

A profit and loss statement (P&L) is an effective tool for managing your business. It gives you a financial snapshot of how much money you're making (or losing) and can make accurate projections about your business's future.

How to Read and Analyze a Profit and Loss (P and L) Statement
Accounting

Here we show you how to break down a P&L statement—how each line item interacts and what they mean for your company's financial performance. Knowing how it all works can help you to better troubleshoot, modify, and plan your daily operations.

 

What is a profit and loss statement?

A P and L statement is a go-to financial statement that shows how much your business has spent and earned over a specific period of time. Your P&L statement shows your revenue, minus expenses and losses. The outcome is either your final profit or loss.

Small business owners have two reporting options when preparing an income statement: a single-step or a multi-step P&L statement.

A single-step profit and loss statement is pretty straightforward. It adds up your total revenue, then subtracts your total expenses, and gives you your net income. A multi-step P&L, on the other hand, requires you to perform multiple calculations in order to arrive at your final net income. The format you choose depends on the type of business you own and the purpose of the P&L you're creating.

You'll sometimes see a P&L statement called statement of operations, income statement, statement of earnings, or more simply, "the bottom line."

You can use a P and L alongside other key financial reports, like the balance sheet and cash flow statement, to check up on and improve the health of your business.

A P&L is typically prepared around tax time. But business owners can run a P&L statement monthly, quarterly, or annually to verify profits and compare certain periods of time to show growth. These comparisons can be helpful for investors and banks who want to see a company's risk level before they will invest or loan to a business.

A note on vocabulary: profit and loss statements are called income statements when they're meant to be shared outside a business. The statement is called a P&L when it's for internal use only. Other than that, though, the two statements are essentially the same.

Profit and loss statement sample

We've created a single-step profit and loss statement for an imaginary business—Accracy Bakery, a small pastry shop.

Accracy Bakery P&L Statement For Year End: December 31, 2021

 
Category Amount
Sales Revenue  $35,710.66
Cost of Goods Sold (COGS) $14,262.38
Gross Profit $21,448.28
Operating Expenses $24,836.61
Kitchen Equipment $1,968.39
Delivery Expense $1,917.52
Wages $9,450.00
Rent $3,250.00
Utilities  $2,091.00
Depreciation Expense $2,978.35
Amortization Expense $857.94
Marketing $291.50
Bank & ATM Fee Expense  $113.06
Taxes & Licenses $240.00
Payroll Taxes  $878.86
Telephone  $799.99
Operating Earnings  $21,016.34
Interest Expense $2,267.62
Earnings Before Income Tax $18,748.72
Income Tax Expense  $10,000.00
Net Profit  $8,748.72

We read profit and loss statements top to bottom, so we'll go through this one line by line.

The components of a profit and loss statement

Here's a quick run-down of what each section in a P and L statement means and where the numbers come from.

Revenue

Knowing how much revenue your business brings in is a key factor in knowing whether it has been profitable. You can measure this either through a cash basis or accrual accounting. The revenue line will be at the top of your P&L and will mark the total revenue accrued during the timeframe you've set out (i.e., quarter or year-end, as in this case).

Cost of goods sold

Cost of goods sold, or COGS, represents what it costs your company to deliver the goods or services. This includes direct expenses such as materials, labor, and shipping but doesn't include indirect expenses such as rent or utilities.

Gross profit

To find out your gross profit, deduct the COGS from your total revenue. This doesn't include overhead costs like rent or upkeep, so it's not a full indication of your profits.

Expenditures

General expenses fall into two categories.

  1. Direct: In the case of Accracy Bakery, that might be employee wages, flour, butter, sugar, ovens—any items directly related to producing bread.
  2. Indirect: These expenses aren't traceable to the production of a product (in this case, bread). For the bakery, that can include overhead costs like rent, maintenance, electricity bills, or gas for delivery vans. You don't include these in COGS.

Operating earnings

Operating earnings measure how profitable your business is, without taking into account external costs, like interest payments, taxes, depreciation, and amortization.

Operating earnings are also called "Earnings Before Interest, Taxes, Depreciation, and Amortization" (EBITDA). Don't worry; it's not as scary as it sounds. Because you have more control over your internal costs than your external costs, many accountants believe EBITDA is the best way to gauge how a business is performing.

Interest expense

Typically, interest expenses arise from a company borrowing money, for example, through a business loan, line of credit, or credit card. Interest expense is the total interest payment you make to creditors for a specific period on your P&L statement.

Earnings before income tax

This is your business's profitability before it pays its income taxes.

Income tax expense

This line shows how much tax you paid on your income.

Net profit

Your net profit deducts all expenses (direct and indirect) from your total revenue. This reveals the total profit your company has made.

Loss

A loss indicates your expenses were higher than the revenue your business brought in. Basically, this shows your business didn't make a profit during this time period and by how much.

How to analyze a profit and loss statement

While it can seem like a daunting pile of numbers, knowing how to review a P and L statement can show you how your business is evolving over time and when it has been most profitable. It can also help you uncover any potential issues with your cash flow.

Here are a few things to keep in mind when reviewing a P&L.

1. Check your bottom line

Curious how your business is doing? Check your bottom line.

The last line of your P&L indicates whether you're "in the black" (earnings were greater than expenses) or "in the red" (expenses were greater than earnings).

While a net profit is always something to celebrate, a net loss doesn't always mean your business is in trouble, especially when first starting out. However, it can indicate any areas that might need attention to ensure losses don't become a pattern.

2. Check your income streams and expenses

Once you know whether your business has made money or not, it's a good idea to take a closer look at your income streams and expenses.

Are your revenue sources in line with your business goals? Are they a one-time or continuous increase? It's good to know if a surge in profit came from gradual growth or a specific event or promotion.

On the other hand, do your expenses make sense for the time period examined? Some costs like rent and utilities might be fixed, while others like supplies or wages could vary.

If your business had a net loss, it's good to see if you can reduce any ongoing costs or if they were necessary for that time period (i.e., increased inventory for the holidays, planned expansion, etc.).

3. Compare your numbers

It's important to compare your P&L statement to previous periods to see if your profit or loss is a trend or an anomaly.

Examining the percentage of change in each category can help you determine if you're on track to meet your goals. Even though a large percentage jump in earnings may seem positive at first glance, if the same period the year prior had very low income, the growth might not be as significant. The same might also be true for expenses.

Once you've made your comparisons, you will have a better idea of what's working or not for your business and if you need to make any changes moving forward.

4. Double-check your math

If you're working in an Excel spreadsheet to build and review your P&L statement, be sure to double-check your numbers to make sure you didn't miss anything or accidentally change a formula. Sometimes, manual data entry can lead to mistakes that affect your bottom line. Reviewing your previous statements can also help in this process.

How Accracy can help

Updating your profit and loss statement helps you check in on the health of your business. Your Accracy account offers an at-a-glance P&L statement, allowing you to review your profitability, identify any cash flow issues, and stay on top of your main expenses month to month.

Spend less time struggling with profitability and more time optimizing it with Accracy. Learn more about how Accracy works.

Get the full picture of your business's financial health

Having a solid grasp of your P&L statement analysis is extremely useful. It helps answer key questions about your business's financial health and how you can keep building revenue to fuel your growth. When your numbers are reliable and up to date, it leaves you more time to focus on the big picture.

 
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