What Does a Profit and Loss Statement Tell You?
A profit and loss statement, also known as a P&L statement, income statement, or statement of operation, is part of bookkeeping and accounting. The statement is a financial report that summarizes revenues, expenses, and profits/losses over a set period. The profit and loss statement shows how well a company generates sales, creates profits and manages expenses. This statement is based on accounting principles, including revenue recognition and accruals. This is one of the things that makes a P&L statement different from a cash flow statement.
What Does a Profit and Loss Statement Tell You?
The profit and loss statement is one of the three financial statements that all public companies must produce every quarter and every year. The other two documents are the cash flow statement and the balance sheet. The profit and loss statement are the most popular financial statements and the most common to include in a business plan. This statement presents a clear sign of how much profit or loss a company accrues over a period.
Much like the cash flow statement, an income statement shows changes to accounts over a set time. This sets them apart from the balance sheet, which only offers a snapshot of the current situation. The balance sheet provides a look at the company’s current financial position for the time it was produced. Business owners and investors must compare the cash flow and income statement. When using accrual accounting methods, a company may log significant revenues or expenses before money changes hands.
Income statements follow a general pattern and are easy to create. The statement starts with a top-line where accountants record revenue. The statement subtracts the costs of doing business, such as the operating costs, costs of goods sold, loan interest, and tax expenses. This difference, known as the bottom line, is called the earnings or profits. There are plenty of templates available online if you’d like take a look at profit and loss statement example.
It would help if you compared different income statements from different accounting periods. This will show you the changes in revenues, research and development costs, operating costs, and net earnings. Those differences may prove to be more significant than the final totals themselves. For example, you could find that your revenues are growing, but expenses are growing even faster. This is an unfavorable situation for any business to be in.
Simply put, the profit and loss statement is a financial report that summarizes revenues, costs, and expenses for a company over a set period. These statements are typically prepared monthly, quarterly, or annually.
The profit and loss statement shows how your business is doing financially, whether it’s generating a profit, and how well you handle expenses compared to revenues.
What Do I Need to Prepare a Profit and Loss Statement?
You’ll need several pieces of financial information to create your profit and loss statement. You will need:
- Banking Transactions
You need to have banking records to create your profit and loss statement. This includes listings of all transactions related to business bank accounts and an outline of business purchases with credit cards.
- Cash Transactions
You will need to get all the receipts for cash purchases related to your business before you can prepare a profit and loss statement. This includes petty cash transactions that apply to the company.
- Income Listings
You will need an account of all income sources for your profit and loss statement. This includes cash, check, credit, and any online payments made by clients for goods and services.
With these documents in hand, let’s look at how to prepare your profit and loss statement.
How to Prepare a Profit and Loss Statement
Creating a profit and loss statement starts with using the accounting equation to calculate profit:
Profit = Revenue – Expenses
Here are the individual steps to preparing an accurate profit and loss statement using the equation detailed above:
- Show Net Income
Start by showing the net income generated by the business. This income typically comes under “Sales.” You can break the total income down into smaller subsections if you find it helpful to split income into different sources for a clear picture of where your money comes from.
- Calculate EBITDA
“EBITDA” refers to the “earnings before interest, taxes depreciation and amortization.” This figure shows the difference between sales and expenses as earnings.
- Account for Any Interest
If you have business debt, then you’ll have to account for interest payments when calculating the profit and loss statement. You can account for interest by subtracting the debt from the EBITDA calculation.
- List Taxes
Now you want to list the taxes on your net income. Deduct the taxes from the revenue.
- Show Depreciation
Now you should show the total depreciation and amortization for the business for the year. Subtract the figure from the revenue.
- Calculate Profit
Once you’ve done all of these other calculations, the figure you’re left with is the net earnings. The net earnings represent the total profits generated by your business. Hopefully, you’ll have made a profit and not a loss for the period.
Why Is a Profit and Loss Statement Useful for Business?
There are several reasons to create profit and loss statements for your business. This statement is helpful for small companies because they show the profit (or the loss) generated by a company across a specific period. The profit and loss statement is a fundamental financial statement used in accounting, alongside the cash flow statement and the balance sheet. When combined, the forecasts of the three statements form the foundation for a business plan and set expectations for the future.
The profit and loss statement is helpful for businesses because it helps you analyze the company’s current financial health. The statement compare money coming into the business against money coming out. It may highlight areas where you can cut costs to save money and increase profits.
The profit and loss statement also makes things easier for your accountant. With this statement in hand, your accountant has less to do to prepare taxes. Preparing a profit and loss statement for the full financial year gives you a document that helps to compile income and expenses ready for filing taxes.
Preparing a profit and loss statement may be a legal requirement, which is one primary reason to create them. These statements are required for publicly traded companies. Such companies must file financial reports with the Securities and Exchanges Commission (SEC), where they are made available for analysts, investors, and regulators. Public companies have to comply with certain guidelines and rules when preparing financial statements. Those guidelines are called the Generally Accepted Accounting Principles or GAAP.
On the other hand, a private company has no legal obligation to stick to the GAAP. Some private companies, especially smaller businesses, don’t bother to create financial statements. However, it is worth considering given all the benefits of having this information to hand. Make better business decisions, have an easier time paying taxes, and keep a close eye on your business’s financial health with profit and loss statement.