TABLE OF CONTENTS
- What Is a Profit and Loss Statement?
- How a Profit and Loss Statement Works
- Why Is a P&L Statement Important?
- Primary Components of a P and L Statement
- Profit and Loss Statement Example
- How to Read a Profit and Loss Statement
- P&L Statement Formula
- How to Create a Profit and Loss Statement
- Profit and Loss Accounting Methods
- P&L Statement vs. Cash Flow Statement vs. Balance Sheet
- Final Thoughts on P&L Statements
- Profit and Loss Statement FAQs
Whether you’re starting your own business or hoping to purchase an existing enterprise, you should know that financial statements, profit and loss (P&L) statements among others, play a significant role in analyzing an operation’s economic health. As one of the most critical financial statements for assessing the viability of a business, profit and loss statements summarize business revenue, track business expenses, and provide an overall picture of profit capabilities.
With around 30 percent of businesses failing before starting their third year of trading, it’s critical for entrepreneurs to understand the financial health of their operations.Entrepeneur.com. “The True Failure Rate of Small Businesses. Accessed July 7, 2023.” Your business’s revenue may be rising rapidly, but that’s meaningless if you cannot keep costs under control and maintain a profit. P&L statements help business owners and other stakeholders understand if a business’s revenue and expenditure can lead to a profit.
This guide explores P&L statements, how they work, why they’re important, their primary components, and various related topics. Continue reading if you want to learn how a profit and loss statement can help you understand the nuts and bolts of your business!
What Is a Profit and Loss Statement?
As its name suggests, a profit and loss statement considers revenues and expenses over a specific period to determine an operation’s profits or losses. This financial statement provides a concise overview of a business’s performance with respect to its revenue and expenditure. A P&L statement offers much more than standard revenue analysis, as it considers how expenses impact an operation’s ability to generate profit.
Public companies must prepare profit and loss statements quarterly and annually to report to the SEC. This is one of the financial documents investors can analyze to determine a company’s value. Although private businesses are not subject to the same reporting requirements, many generate P&L statements to track business performance and identify trends.
For the sake of clarity, it’s also essential to understand other terms are interchangeable with the term P&L statement:
- Expense statement
- Earnings statement
- Profit loss statement
- Income statement
- Statement of operations
- Statement of profit and loss
- Statement of financial results or income
How a Profit and Loss Statement Works
A P&L statement offers a straightforward overview of a business’s performance over a specified period. As such, it serves as an excellent tool for comparing performance trends.
To prepare a P&L statement, begin by listing your business’s revenue for a given period at the top of the statement. Next, list the various business costs; this may include marketing, tax, interest, and other operating expenses. The difference between revenue and expenses constitutes your business’s net income. If this figure is positive, your business turned a profit; if negative, it suffered a loss.
When viewing a business’s profit and loss statement, multiple periods (quarters, years, etc.) will likely appear next to one another. This allows for easy comparison across multiple periods, making it simple to analyze trends, such as whether expenses rise at the same rate as revenue.
Why Is a P&L Statement Important?
Running a business is hard work. It requires much more than operational experience—you must also have a firm grasp of your business’s revenue, costs, and other relevant financial data. This includes understanding the financial statements responsible for illustrating said data.
That said, let’s delve into the four primary reasons why P&L statements are crucial to your business:
If you run a publicly traded company, you must prepare P&L statements to comply with the SEC requirements. Some private companies also prepare these statements, albeit less commonly. Always ensure you understand the federal requirements for your business.
2. Performance Assessment
A P&L statement enables a business’s management team to evaluate its performance. Comparing P&L statements across different periods gives a clearer picture of the correlation between a business’s revenue and costs.
3. Taxation Assistance
When tax season arrives, a P&L statement can shed light on how much corporate tax a business owes. Regularly preparing P&L statements can greatly simplify tax processes for your business.
4. Evidence for Potential Investors or Lenders
Regularly prepared P&L statements can help your business attain investment or lending at short notice. Potential investors or lenders want proof your company has a viable business case. Displaying your financial information in context (i.e., P&L statements for multiple quarters or years) can boost your business’s chances of securing funding.
Primary Components of a P and L Statement
A P&L statement has four primary components. Let’s explore each in more detail below:
Revenue is the first item on a P&L statement. Let’s explore some items in the revenue portion of your P&L statement:
- Rental Income
- Commissions Earned
- Fees Charged
- Interest Income
Cost of Goods Sold (COGS)
The cost of goods sold (COGS) is the figure your business pays for inventory or materials. Your business must subtract the COGS from your revenue to determine gross profit. For example, if you source a computer from a wholesaler for $800 and you sell it for $1,000, then:
- Your revenue is $1,000.
- Your COGS is $800.
- Your gross profit is $200.
Your business’s expenses refer to various types of expenditure, including:
- Professional Fees
- Administrative Costs
- Salaries, Benefits, and Wages
- Interest Expense
- Telecommunication costs
Profit and loss
Finally, by subtracting expenses from gross profit, your business can determine pre-tax income. After deducting interest and taxes, the result is your net income. A positive net income signifies a profit, while a negative net income indicates a loss.
The primary purpose of a P&L statement is to identify if a business is running a profit or a loss.
Profit and Loss Statement Example
Viewing an example of a profit and loss statement can help you understand how to prepare one for your business. As an illustration of how a large public company would prepare a balance sheet, let’s explore Starbucks’ profit and loss statement from 2022 and 2021 (Values are in $USD millions, aside from per share data):Macrotrends. “Starbucks Financial Statements 2009-2023 | SBUX“. Accessed July 7, 2023.
|Starbucks Income Statement (P&L Statement)||2022-09-30||2021-09-30|
|Cost of Goods Sold||$10,317.4||$8,738.7|
|-Research and Development||–||–|
|-Other Operating Income or Expenses||$-13,789.2||$-11,905.1|
|Total Non-Operating Income/Expense||$-385.9||$484.8|
|Income After Taxes||$3,283.4||$4,200.3|
|Income from Continous Operations||$3,283.4||$4,200.3|
|Income from Discontinued Operations||–||–|
|Basic Shares Outstanding||1,153||1,178|
|EPS – Earnings Per Share||$2.83||$3.54|
How to Read a Profit and Loss Statement
Reading a profit and loss statement can tell you a lot about a company. But as there are various ways to interpret a profit and loss statement, we’ll explore some of the most useful ways of reading this document:
Compare performance over different time periods
Profit and loss statements enable business owners to monitor performance over time. For instance, although revenue may have increased from one year to the next, overall expenses might offset the benefits. P&L statements help identify how changes in income and expenditure impact profits, which is why preparing monthly or quarterly P&L statements can be advantageous.
Benchmark performance against industry competitors
A good way to determine if a company is performing well is to benchmark it against industry competitors. Different industries have different margin expectations. For example, if a business has low margins but exists in a low-margin industry, it may still be considered a good performer if it fares better than its competitors.
Likewise, viewing multiple P&L statements from existing businesses can help determine profit potential if you’re an entrepreneur seeking a new industry. This process will help you steer clear of industries with unappealing margins.
Also, always look at other critical financial statements when analyzing a company. Balance sheets, cash flow statements, and other financial documents will also help determine if a company is financially healthy.
P&L Statement Formula
Your accountant may use a P&L statement formula to determine your operation’s profitability. While this sounds complex, the formula itself is very basic:
Total Revenues – Total Expenses = Net Income
Start by adding up all your business’s revenues and expenses. Next, subtract the total expenses from the total revenues to reveal net income. If your revenues exceed expenses, your business will turn a profit; if your expenses exceed revenues, your business will be operating at a loss.
To use the P&L statement formula, your business must be able to attain figures for total revenues and total expenses. It’s critical to collect all relevant financial items for both categories; otherwise, the net income won’t be an accurate reflection of your business’s health.
How to Create a Profit and Loss Statement
Creating a profit and loss statement is simple if you have all the correct data. Below, let’s explore a step-by-step guide for preparing a basic P&L statement:
- Determine overall revenue.
- Determine overall expenses.
- List revenue on the top of the spreadsheet.
- List costs of goods sold (COGS) below revenue.
- Subtract costs of goods sold (COGS) from your overall revenue.
- List expenses (aside from interest on business debt) on individual lines (i.e., itemize marketing expenses, administrative expenses, etc.).
- Determine EBIT by subtracting expenses from gross profit (determined in step 5).
- List interest expense.
- Subtract interest expense from EBIT to find Earnings Before Taxes.
- List estimated taxes on net income.
- Subtract estimated taxes from Earnings Before Taxes to reveal Net Income.
Below, let’s explore an outline for a basic P&L statement to illustrate the steps listed above:
|FY 2022||FY 2021|
|Total Net Revenue||–||–|
|Depreciation & Amoritization||–||–|
|Salaries, Benefits, and Wages||–||–|
|Earnings Before Taxes||–||–|
Remember that your business will likely have more expense categories than the above template. The template is for illustrative purposes only.
Profit and Loss Accounting Methods
Profit and loss statements can be formed using two accounting methods: cash method and accrual method. The method your business chooses for accounting purposes will significantly impact the figures in your statement. Therefore, it’s critical to understand the core differences between each method:
The cash method is an accounting method commonly used by smaller businesses. With the cash method, a business only accounts for revenue or expenditure when it receives money or pays expenses. For example, if a computer company sells 30 computers to a customer, it will only record the sale as revenue when the customer pays the invoice. Likewise, if the same computer company has an electricity bill for one of its retail locations, it will only record the bill as an expense when it pays cash for the utility bill.
On the other hand, the accrual method accounts for revenue and liabilities as they occur. For example, if a computer company sells 30 computers to a customer, the sale will count as revenue when the computers are delivered, even if the customer is yet to pay the invoice. Likewise, if the same computer company owes a utility company money for an electricity bill, this will count as a liability, even if the payment is yet to be made.
P&L Statement vs. Cash Flow Statement vs. Balance Sheet
A profit and loss statement is one of three major financial statements utilized by analysts for assessing a business’s performance. The other two are cash flow statements and balance sheets. To understand the financial health of a business, understanding these three statements. So, here’s a bit about the other two.
Cash flow statement
A cash flow statement analyzes a business’s ability to meet its day-to-day cash flow needs. So, while your P&L statement determines if your business is running a profit or a loss, a cash flow statement assesses what cash is incoming, outgoing, and currently available.
So, wouldn’t a business turning a profit automatically have a positive cash flow statement? Not necessarily.
Large one-time costs, late invoice payments, and other issues can all impact cash flow. Managing cash flow effectively helps your business ensure it meets its financial obligations and maintains strong credit. For this reason, it’s always critical to prepare a cash flow statement alongside a P&L statement.
Balance sheets contain much of the same information as a P&L statement, but there are a few key differences. Firstly, balance sheets focus on assets, liabilities, and shareholder equity, whereas a profit and loss statement focuses on revenue and expenses. Secondly, the purpose of a balance sheet is to display a company’s financial status at a specific point in time, whereas a P&L statement covers a specific period of time (i.e., quarter, year, etc.). Balance sheets display the value of a company, and P&L statements prove how much money a company is generating during a specific period.
Final Thoughts on P&L Statements
P&L statements play an integral role in monitoring a company’s financial health. Whether you’re assessing your own business or monitoring a public company’s performance, it’s essential to understand how to prepare and read P&L statements. This financial statement helps business owners understand the interaction between expenses and revenue.
As expenses are a critical element in a P&L statement, it’s essential for businesses to reduce their credit card processing rate. Doing so can increase profits!
Profit and Loss Statement FAQs
What is a multi-step income statement?
A multi-step income statement is a detailed P&L statement that allows for a more thorough analysis of revenue and expenses. It separates operating revenues and expenses from nonoperating income and costs, offering a clearer understanding of a business’s revenues and expenses.
What are considered expenses on the profit and loss statement?
Here are some common expenses present on a profit and loss statement:
- Costs of Goods Sold
- Professional Fees
- Administrative Costs
- Salaries, Benefits, and Wages
- Interest Expense
- Telecommunication costs
How often are profit and loss statements created?
The frequency of creating profit and loss statements varies depending on the business, its reporting requirements, and other factors. While some small private companies may not need to create P&L statements, larger companies create them quarterly and annually. Public companies must also submit these to the SEC.
Are all companies required to prepare profit and loss statements?
Publicly listed companies must prepare profit and loss statements and file them with the SEC quarterly and annually.SEC. “Exchange Act Reporting and Registration.” Accessed July 7, 2023. This is one of the many compliance requirements for companies traded on stock exchanges in the United States.
However, private businesses may not need to do so. Nevertheless, routine preparation of financial statements helps managers monitor business performance and plan for the future.