A profit and loss statement, like a cash flow statement, gives you specific information about your company’s revenues and expenses; which makes it one of the most important aspects of a business plan. So to set you on the right path for business growth and effective financial planning, we will go through the steps on how to create, read and understand a profit and loss statement.
What is a Profit and Loss Statement?
The income statement, often known as the profit and loss statement (P&L), is the most well-known and widely used financial statement in any business plan. When bankers and investors look through your business plan, they’ll start with the financial statement.
The profit and loss statement (P&L) determines whether or not your business is profitable. It begins with an overview of your revenue, then goes into detail about your costs and expenses before displaying the crucial “bottom line”—your net profit.
Additionally, a profit and loss statement can be used to create a budget or calculate your working capital.
How to Create a Profit and Loss Statement?
The frequency with which you run a profit and loss statement is entirely up to you. Some businesses prefer monthly profit and loss statements, while others prefer quarterly reports.
Although using accounting software takes care of the entire procedure for you, it is pretty vital to understand the process of preparing a profit and loss statement. This is because even with a software, you should also be able to read and interpret the results.
Going through this process will help you better achieve this without stress.
Step 1: Calculate Revenue
Weighing all of your company’s revenue is the first step you need to create a profit and loss statement. Current account balances, such as cash and current accounts receivable, can be found in your general ledger.
If you’re preparing a monthly profit and loss statement, you’ll need to include all revenue received during that time period, whether or not your company has collected it. Alternatively, simply add up the revenue earned during the three-month period if you’ve elected to run a quarterly statement.
Also, include all revenue collected, whether it’s from selling items and services or selling your old printer to the firm next door when determining revenue.
Step 2: Calculate Cost of Goods Sold
Any profit and loss statement must include your cost of products sold. If you’re selling wallets, you’ll need to factor in the cost of buying them from the manufacturer.
On the other hand, you’ll need to include the materials and supplies needed to make the wallets if you’re producing them.
If you’re selling services, you’ll need to factor in the cost of your time or the time of your employees who supplied the service.
Step 3: Subtract Cost of Goods Sold from Revenue to Determine Gross Profit
Once you’ve determined your revenue and cost of goods sold, all you have to do now is subtract the cost of goods sold to get your gross profit value. The profit your company makes from selling its products and/or services is referred to as gross profit.
Gross Profit/Loss = Revenue – Cost of Goods Sold
Step 4: Calculate Operating Expenses
Now the next step will be to identify and calculate all of your operating costs. Rent, travel, wages, equipment, utilities, and postage all fall under this category.
Step 5: Subtract Operating Expenses from Gross Profit to obtain Operating Profit
After you’ve determined your operating expenses, deduct them from the total to get your overall operating profit. Your total operating profit or loss will be calculated as a result of this.
Operating Profit/Loss = Gross Profit – Operating Expenses
Step 6: Add Additional Income to your Operating Profit
If you have any additional income that isn’t already included in your revenue totals, such as interest or dividends from investments, you should enter it here. EBITDA stands for earnings before interest, taxes, depreciation, and amortization, and is calculated by adding your operating profit to it.
Mathematically;
Operating Profit + (Interest Income + Dividends Paid) = EBITDA
Step 7: Identify Interest, Taxes, Depreciation and Amortization
The next step is to figure out any outstanding interest payments, taxes, and depreciation, and amortization costs.
Step 8: Subtract Interest, Taxes, Depreciation, and Amortization Expenses from EBITDA to Obtain Net Profit
To get at your net income, or net profit, you must first subtract interest, taxes, depreciation, and amortization expenditures.
Mathematically;
EBIDTA – (Interest + Taxes + Depreciation) = Net Profit/Loss
What Does a Profit and Loss Statement Tell You About Your Company?
For starters, a profit and loss statement shows you how well your company is performing. A profit and loss statement, which is commonly used to assess both strengths and shortcomings in enterprises, can also tell you the following:
#1. Whether or Not Your Services or Products Are Profitable
Because we’re all in business to generate money, it’s no surprise that your gross profit is one of the most crucial indicators for your company. Like I said earlier, by deducting the cost of products sold from the revenue collected, you get your gross profit.
This number tells you how profitable your services are or how well your products are performing.
Tip: Increase your sales if your gross profit is low.
#2. Whether or Not Your Company Is on the Right Track
It’s essential to look at trends when reviewing your profit and loss statement. Comparing reports can help you see how your firm is trending, whether you measure profit and loss on a monthly or quarterly basis.
For example, if your net profit in January was $10,000 but fell below $4,000 in February, March, and April, you’ll need to dig deeper into your business finances to figure out what went wrong. You can start by looking at gross profit. If your gross profit is low, your best course of action is to boost sales.
If, on the other hand, gross profit has remained stable but net profit has decreased, this indicates a rise in operational expenses, and you should start searching for ways to minimize costs.
While a single profit and loss statement is useful, comparing them is considerably more so.
#3. How Healthy Your Business Is Overall
The end result. When you give investors or financial institutions financial documents, their attentions are drawn to the bottom line: net profit. While a loss isn’t the end of the world, it does indicate that something is wrong, whether it’s a one-time issue or an ongoing problem.
In either case, the profit and loss statement allows you to see exactly where your company stands financially, allowing you to make smarter business decisions.
How to Read and Comprehend Your Profit and Loss Statement
Unlike the cash flow statement, which can be confusing, your P&L is relatively simple to read and comprehend. To help you read and understand you profit and loss statement effectively, here’s a rundown of what each section means and where the numbers come from.
#1. Revenue
The money you bring in from your sales is referred to as revenue, or the “top line” of the P&L.
This is money raised from fundraising if you’re a non-profit. A company’s sales are usually detailed in a separate table, and the total sales number is then transferred to the P&L.
Of course, revenue is a crucial figure because it is what you need to pay your bills. The lower your income amount is, the lower your expenses must be to remain profitable.
#2. Direct Costs
Direct costs, also known as the cost of goods sold (COGS), are the expenses you spend when creating or delivering your products or services. Rent and payroll aren’t included here, but you would include the items that directly contribute to each sale.
For example, the direct cost of each sale for a bike shop is the price paid by the shop to purchase the bikes from the manufacturer. Direct costs for a bike maker would include the cost of the metal and plastic required to construct the bike.
If you work as a consultant, though, you may have very minimal or even no direct expenditures. You may incur expenditures for printing reports and photocopying, but there aren’t many other expenses.
#3. Gross Margin
After you’ve covered the cost of the product or service you’re selling, your gross margin tells you how much money you have leftover to meet your expenses. You may calculate your gross margin by subtracting your direct costs from your revenue.
Gross Margin = Revenue – Direct Costs
Your gross margin would be $2 if you bought a widget for $1 and sold it for $3.
The gross margin percentage is a percentage representation of the figure; the larger the number, the better. This percentage is calculated by dividing your gross margin by your revenue:
Gross Margin / Revenue = Gross Margin %
When you have a large gross margin, it means that it costs you very little to supply your product or service, and you’ll be able to cover your expenses with the bulk of the money from each transaction.
#4. Operating Expenses
These are all of the charges you incur to keep your business open, minus the direct costs we discussed before.
Operating Expenses = Expenses – Direct Costs
Rent, salaries and benefits, marketing expenses, research & development expenses, utilities, and so on are typically included. However, don’t include loan interest or taxes in this calculation.
#5. Operating Income
EBITDA, which is also known as operating income, stands for (earnings before interest, taxes, depreciation, and amortization). This is derived by deducting your gross margin from your overall operating expenses.
Operating Income = Gross Margin – Total Operating Expenses
#6. Interest
Include any interest payments made by your company on any outstanding loans in this section.
#7. Amortization and Depreciation
These are one-time costs linked with assets owned by your organization. Assets (such as vehicles and large pieces of equipment) lose value or degrade over time. This is where you’ll deduct the loss in value.
#8. Taxes
Any taxes you have paid or anticipate paying on your sales are listed here.
#9. Profit after taxes
It’s the “bottom line” that you hear so much about, sometimes known as net income or net earnings. You started with your income as your “top line,” then deducted things like direct costs, operating expenses, and so on as you went. What’s leftover is your profit, or even your loss if you spent more than you earned.
That’s how to read your profit and loss statement. But keep in mind that profits are not the same as cash. Just because you made a profit doesn’t mean you have money in your bank account.
How Do I Do a Profit and Loss Statement?
In doing or creating a profit and loss statement, the steps are straightforward. These steps include;
- Calculate revenue. …
- Calculate cost of goods sold. …
- Subtract cost of goods sold from revenue to determine gross profit. …
- Calculate operating expenses. …
- Subtract operating expenses from gross profit to obtain operating profit.
What Items Are Included in a Profit and Loss Statement?
There are five major items included in a profit and loss statement;
- Revenue (sales/turnover)
- Cost of goods sold (COGS)
- Gross Profit (revenue minus COGS)
- Expenses.
- Net profit (gross profit minus expenses)
What Are the 3 Major Line Items on the Profit and Loss Statement?
The major line items starts with a top-line entry for revenue and subtracts the costs of doing business, such as cost of goods sold, operational expenses, tax charges, and interest expenses. Net income, also known as profit or earnings, is the difference, often known as the bottom line.
Is P&L Same as Income Statement?
The income statement, often known as the profit and loss statement (P&L), is the most well-known and widely used financial statement in any business plan. When bankers and investors look through your business plan, they’ll start with the financial statement.
What Are the Steps to Calculating Profit & Loss?
To calculate the accounting profit or loss:
- Add together all of your monthly income.
- Add up all of your monthly expenses.
- Subtract entire expenses from total revenue to calculate the difference.
- The outcome is your profit or loss.
