Want to know how profitable your business is? The best way to find out is to create a profit and loss statement.
A P&L statement (sometimes called a statement of operations) is a type of financial report that tells you how profitable your business was over a given period. It shows your revenue, minus expenses and losses. The result is either your final profit (if things went well) or loss.
The P&L statement is one of the three most important financial statements for business owners, along with the balance sheet and the cash flow statement (or statement of cash flows).
One of the most common reasons small businesses start producing profit and loss statements is to show banks and investors how profitable their business is.
When profit and loss statements are meant to be shared outside a business, they're called income statements. A P&L statement is for internal use only. Other than that, the two statements are essentially the same.
We've created a profit and loss statement for an imaginary small business—Terracotta Warriors, a supplies store for potted plant enthusiasts.
Terracotta Warriors Inc.
Income Statement
For Year Ended Dec. 31, 2021
Profit and loss statements should be read top to bottom—so we'll go through this one line by line, starting at the first.
Further reading: How to Read (and Understand) an Income Statement
Every profit and loss statement starts off by showing your company's revenues.
How you calculate your revenue depends on whether you do cash or accrual accounting and how your company recognizes revenue—particularly if you're tracking income for a single month (rather than a year, as part of an annual report.)
The sales revenue line simply represents your total revenue for the time period you're reporting. (In this case, it's the year ending on December 31, 2021.)
Abbreviated as "COGS," this is the cost of producing the goods or services you sold to your customers during the reporting period.
COGS involves only direct expenses: Raw materials, labor, and shipping costs. In the case of Terracotta Warriors, that might include planting pots (purchased wholesale), wages for employees, and the cost of shipping online orders.
Indirect expenses—for instance, utilities, bank fees, and rent—aren't included in COGS. Those go into a separate category.
When you subtract COGS from your sales revenue, you get gross profit. This number tells you how profitable your business is after taking into account direct costs, but before taking into account overhead costs. You can consider it a rough measure of how your business is performing.
General expenses
Also referred to as "operating expenses," general expenses include rent, bank & ATM fees, equipment expenses, the cost of marketing & advertising, merchant fees, and any other expenses you incur in order to keep your business running.
Some profit and loss statements will bundle these and similar expenses together into one broad category: Selling, General & Administrative Expenses (SG&A). In our example, though, they're broken out into individual line items.
Once you take into account all internal costs, you get your operating earnings. It's a measure of how profitable your business is, without taking into account external costs, like interest payments, taxes, depreciation, and amortization. Operating earnings is sometimes called EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization).
You have considerably more control over your internal costs than your external—taxes, interest payments, and other expenses are partly determined by the work of financial professionals. For that reason, many accountants consider EBITDA the best measure of how a business is performing.
Operating earnings are sometimes called operating profit or operating income. And EBITDA are sometimes referred to as non-operating expenses.
If your business has a loan, line of credit, or credit card, it's likely you need to make monthly interest payments. Your interest expenses are the total interest payments you made to creditors for the period covered by the income statement.
This line shows your business' profitability before it pays its taxes.
This is how much tax you paid on your income.
This is where the term "bottom line" comes from. The bottom line of the profit and loss statement is your net earnings—the total profit for your business, taking into account all internal and external expenses.
If you have a bookkeeper or accountant, they may already generate P&L/income statements for you. Likewise, many types of accounting software will automatically generate useable income statements, so long as you accurately categorize all your transactions.
The profit and loss statement above is technically called a "multi-step" P&L statement. That's because you have to perform multiple calculations in order to arrive at your final net income. (In this case, we calculated gross profit, then subtracted general expenses, then subtracted interest, and then income tax expenses.)
A single-step profit and loss statement is a bit more straightforward. It adds up your total revenue, then subtracts your total expenses, and gives you your net income. Simple.
We created an example single-step profit and loss statement for another hypothetical company, the Pot Barn:
The Pot Barn Inc.
Profit and Loss Statement
For Year Ended Dec. 31, 2021
The single-step format is good at giving you a snapshot of your company's profitability, and not much else. That's why it's not as common as the multi-step P&L statement. But if you'd like a super simple method of calculating your business' profitability, single-step is the ticket.
Common size profit and loss statements include an extra column of data summarizing each line item as a percentage of your total revenue.
Here's the profit and loss statement for Terracotta Warriors Inc., done up this time as a common size P&L statement:
Terracotta Warriors Inc.
Profit and Loss Statement
For Year Ended Dec. 31, 2021
Common size profit and loss statements can help you compare trends and changes in your business.
For example: if your Operating Earnings change from $21,052.44 to $23,443.33, that might not tell you much by itself, because other numbers might have changed as well. But if your Operating Earnings increase from 36.90% to 44.23%, that's a concrete, significant change in your business.
A balance sheet shows you how much you have (assets), how much you owe (liabilities), and how much is left over (equity). It's a snapshot of your whole business as it stands at a specific point in time.
A profit and loss statement describes how profitable your business is. It shows you how much money flowed into and out of your business over a certain period of time.
Further reading: Income Statements vs. Balance Sheets
How Accracy can help
An up-to-date profit and loss statement helps you keep an eye on your business's financial health so you can identify cash flow issues before they become a problem.
Your Bench account's Overview page offers an at-a-glance profit and loss statement, allowing you to review your profitability and stay on top of your top expenses from month to month. Spend less time figuring out your profitability and more time optimizing it With Accracy. Learn more.
We are offering free 1 Month Basic Bookkeeping to all new customers so you can experience Accracy's seemless and professional services.
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