The profit and loss statement plays a key role in your small business accounting. It provides a summary of total income and expenses over a specific period of time, plus it serves as an indicator of your company’s financial health.
Before we dive into how to read a profit and loss statement, let’s review what it is and what this statement shows for a business’s profitability.
What Is a Profit and Loss Statement?
A P&L statement, also known as an income statement, tracks profits that remain after deducting costs from revenue within a specific accounting period, which can be monthly, quarterly, or annually.
The P&L statement is also called an earnings statement, a revenue statement, an operating statement, a statement of operations, or a statement of financial performance.
In the P&L, profit is referred to as net income or net profit, which appears on the last line—which is where the term “bottom line” comes from. But before you hit the bottom line, the data above it provides valuable insight on performance over time.
Let’s review what that data entails and how it can help a small business owner make more informed financial decisions.
Why Is It Important to Understand Your P&L Statement?
The P&L statement provides a breakdown of revenue generated and expenses incurred. This allows you to see how profitable your business is and how much money is left over after losses are accounted for.
For instance, if your P&L statement shows gains, then you might want to allocate more funds toward growing the business, increasing budgets or salaries, or paying off debt. If you need to reduce losses, then the P&L can show what costs you can consider cutting.
What Does a P&L Statement Show About Your Business?
There are three key insights that the profit and loss statement provides:
- Where your profits come from. If your business sells multiple products or services, each can be broken down on the P&L, so you can see which ones are most profitable and if revenues for each increase or decrease over time.
- Whether your costs are managed efficiently. Comparing your current P&L data against prior P&L statements can tell you if certain expenses are rising faster than expected. For instance, if business revenue increased 20% from the preceding quarter, but operational expenses went up 60%, you’ll want to know what caused those costs to go up and see where cuts can be made.
- If your business is profitable: The P&L statement tracks your business’s financial performance over time. Looking at the bottom line shows where your business is in its financial life cycle and if it is turning a profit, breaking even, or in the red.
How to Read a Profit and Loss Statement
Each profit and loss statement looks a little different depending on the type and size of the business. If a company sells many products or services, has several sources of income, or has many expenses, these factors can make the P&L more complex.
Below are some formulas used in profit and loss statements:
- 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
Below is a breakdown of some terms and what they refer to on your P&L statement.
- Revenue: These are net sales during the accounting period, including revenue from primary business activities and other activities.
- Cost of Goods Sold (COGS): This is what it costs to produce the business’s products or to deliver its services. This includes labor, materials, transportation, and other expenses.
- Gross Profit: Also referred to as gross income or gross margin. This is calculated as net revenue minus the cost of goods sold.
- Operating Expenses: These are the costs of running the business. They can be variable (labor, supplies, payroll), fixed (rent), accrued (expenses incurred but not yet billed), and non-cash expenses (depreciation).
- Operating Income: This is income before taxes, depreciation, interest, and authorization. It is calculated by subtracting operating expenses from gross profit.
- Other Income and Expenses: This accounts for one-off or infrequent income and expenses unrelated to regular business operations. This could include revenue from the sale of company assets or the cost of repairs.
- Net Profit: As the bottom line of the P&L statement, this is the total amount earned after deducting expenses, calculated as gross profit minus total expenses.
Need More Help with Your Revenues and Expenses?
The profit and loss statement is one of the three financial statements recommended for small businesses to consistently use, in addition to the cash flow statement and balance sheet. Read more here about how these statements differ and why you need each financial report for your small business accounting.
The Oregon SBDC Network offers training statewide. Learn small business accounting basics, methods, bookkeeping, and QuickBooks—a cloud-based mobile (or online) app for financial reporting and management. To find small business accounting support near you, contact your local Center today.
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