A Beginner’s Guide to a Profit and Loss Statement
What is a profit and loss statement? There are many financial statements that your business should maintain and refer to, key among these is your profit and loss (P&L) statement. But why is it so important, what can you learn from it, and how do you calculate P&L?
A P&L statement is an important indicator of your business’ health – across its lifecycle. As a startup, it can tell you if you’ve reached break-even point. This is the point at which the total cost of goods produced or sold equals the revenue the business makes. Understanding your break-even point can help you price your products, set revenue targets, and identify missing expenses. It’s also a critical part of your business plan. Investors will want to know at what point you stop losing money and begin to turn a profit.
A P&L statement will also show how your business performs over time; breaking down revenue generated, and expenses incurred. With these insights, you can see how profitable your business is and how much cash is left over after your losses are accounted. These funds can be used to grow your business, pay off debt, or contribute to your salary as a business owner. The statement also informs where you may need to cut costs to reduce losses and drive revenue.
How do you calculate P&L?
Your P&L statement will draw on the following data points and calculations:
- Net Sales (or revenue) – Cost of Sales (or Cost of Goods Sold) = Gross Profit (or Gross Margin)
- Gross Profit – Operating Expenses = Net Operating Profit
- Net Operating Profit + Other Income – Other Expenses = Net Profit Before Taxes
- Net Profit Before Taxes – Income Taxes = Net Profit (or Loss)
These terms can be confusing. Let’s look at what each means:
Revenue: The net sales your business made during a certain period. This data point should reflect revenue from your primary business activity but also any gains from other activities such as the sale of assets.
- Cost of Goods Sold (COGS): The calculation of all the costs involved in manufacturing or selling a product. These typically include materials, transportation, storage, and labor costs. Knowing your cost of goods sold can help you determine how to price your products to maximize profitability and ensure you’re maintaining sustainable margins. It will also help you identify which product lines may be killing your profitability.
- Gross Profit: You can arrive at this number by deducting the cost of sales from your business’ net revenue.
- Operating Expenses: Expenses are the costs incurred in the daily running of your business – from rent to marketing, training to vehicle mileage. What’s included in operating expenses? The costs can be variable (the cost of labor, materials, supplies, wages), fixed (rent), and accrued (expenses that are incurred but not yet billed for)
- Net Operating Profit: The profit that remains once you’ve deducted selling and administrative costs or expenses.
- Other Income and Other Expenses: These buckets account for any income or expenses that aren’t related to your company’s main business operations. For example, other income could include royalties, dividends, or gains from the sale of property or other capital assets. Other expenses refer to the costs associated with unexpected losses like repairs or tax penalties.
- Net Profit Before Taxes: These are your company’s profits before paying income tax.
How do you fill out a profit and loss statement?
There are many freely available P&L statement templates that you can use. Search online or use one of many Microsoft Office templates. You may need to create separate spreadsheets to calculate each of the data points before entering them in your main P&L statement.
How often should you update your P&L statement?
Set a goal to update your P&L statement frequently. This may be once a month or once per quarter. If your business is new, your update cycle may be more regular. This allows you to keep an eye on profits and satisfy the needs of investors. Updates will also be prompted by tax season, a new product launch, expansion into a new geography, or the emergence of a new competitor on the block (if your profits are dropping you may need to shift your marketing strategy).
How do you interpret your P&L statement?
Making sense of your P&L statement is even more important than maintaining one. If you’re struggling to understand what the numbers are telling you, have a conversation with an accountant. They can help you understand where revenue is being generated, any pitfalls to profitability, and where costs need to be cut.
Online accounting software can also support your analysis. Charts and graphs help you visualize key information. You can also drill down to get a more detailed view into transactions associated with each graphic. These reports can also be easily shared with an accountant.
What is the difference between a P&L statement and a balance sheet?
A balance sheet is a snapshot of what your business owns (its assets) and what it owes (liabilities).The balance sheet won’t inform your profitability or cash flow, however, it is the leading indicator of the overall stability and liquidity of your business and is a useful tool for determining how much cash your business has on hand and your ability to fund growth.