How to prepare a Profit and Loss (P&L) statement
A Profit and Loss statement is a straightforward way to summarise expenses and income during a period of time. These profit and loss statements help owners understand the financial health of a business.
Analysing profit and loss statements across various periods can offer detailed insight into a business' costs. In addition, you might notice trends in your P&L report, which could provide valuable information when looking to save, grow, or invest in other areas.
What is a Profit and Loss (P&L) statement?
A statement of profit and loss offers an in-depth view of the monetary health of an enterprise over a specific time period. A P&L statement may also be referred to as an expense statement, income statement, earnings statement, statement of operations, or statement of financial results or income.
P&L reports are different from balance sheets in that a balance sheet only tells you about a business' financial status at a particular point in time. A P&L statement provides more visibility into operating costs, revenue, and earnings over time minus your expenses for a set period.
P&L statement vs. balance sheet vs. cashflow statement
Financial jargon can be nuanced and confusing. Below we detail the key differences between these 3 crucial terms.
A P&L statement is an account of a company's income and expenditures (and ultimately its profit) over a period of time. P&L statements provide insight into a company's financial position and are typically produced to the public every month, quarter, or year. Investors might use this information in conjunction with a company's balance sheet and cashflow statement to analyse the organisation's profitability.
A balance sheet shows a company's assets (what they own) and liabilities (what they owe). Assets could include cash, sales, accounts receivable, or longer-term assets, like property and equipment. Liabilities might include wages payable or long-term liabilities like bank loans.
A cashflow statement, or statement of cashflow, provides comprehensive data reflecting all sources of cashflow a company receives from external investments and current operations. In addition to incoming cash, a cashflow statement also provides data on cash outflows that a company pays for, such as business expenses or investments during a specific period.
How do P&L statements work?
P&L statements help provide a financial account or overview of a company's financial health that summarises the costs, expenses, and revenue made during a specified period. Companies might generate a P&L statement for a single month, quarter, or year.
To construct a P&L statement, you'll need the following:
cost of product sold
All P&L statements follow a general format. Starting with revenue entry, known as the "top line," you then subtract the costs of doing business (such as rent, taxes, operating expenses, interest, product expenses) from the revenue. The result is the profit, otherwise known as a net income, or "bottom line."
P&L statement examples can typically be found online, allowing further insight into how different businesses format their statements. Searching for examples from companies in the same industry as yours or from a corporation that uses a similar business model could be particularly helpful.
Templates are often easy to find, which you can download for your own use to organise finances; you can even search for a specialised P&L statement for small businesses. In addition, automated accounting software can often help tremendously, saving you from tedious data entry and human error.
What is a P&L statement used for?
Small businesses can use profit and loss statements in various ways.
Investor or loan application
One application for a profit and loss statement could be as a projected document to entice investors or for a startup business loan application. Investors and banks will want to see how a business expects to make a profit before handing over money.
Financial health of the business
P&L statements are also helpful when determining the financial health of a business. For example, small and large companies can benefit from internal analysis using profit and loss accounts. In addition, some analyses compare sales expense numbers and prior budget figures to calculate whether a business has met financial goals over a period of time.
Tax preparation is another important scenario in which P&L statements are helpful. While taxes often make us cringe, keeping detailed reports can help avoid a financial mess when it comes to books and accounting. A tax preparer may use a detailed business profit and loss statement for the entire year to create a tax return at the end of the fiscal year for a company.
Types of P&L statements
Companies may keep records of profits and losses using 1 of 2 methods.
The cash method is a simple way to account for cash received or cash paid. This method is often used by small businesses or by an individual for keeping track of personal finances.
A cash method refers to when a corporation records each transaction every time cash is received (recorded as revenue), and each time cash is paid out (recorded as liabilities) towards bills, business expenses, loans, wages, and so on.
The accrual method is used when a company records revenue (profits) it expects to obtain in the future, despite the cash not yet received. The accrual method is commonly used by medium to large businesses.
A company using the accrual method will record revenue on its P&L statement once goods are incurred, even though the goods have yet to be paid for because the company expects payment to be made in the future. Similarly, when using the accrual method, the business will also record expenses (losses) it intends to make in the future, even if it has yet to pay for the expenses.
What a P&L statement includes
Below we explain the categories that comprise a P&L statement and why each section is necessary.
Often referred to as the "top line," revenue is a company's money from sales. As you likely know, revenue is critical to an organisation's success. The greater your expenses, the greater your revenue needs to be to remain profitable.
Cost Of Goods Sold (COGS), or direct costs, are the costs incurred when making or delivering products or services. While rent or payroll wouldn't apply here, you would include the cost of the metal to create a car, for example.
Expenses include all the costs incurred to keep a business running, like rent, salaries, utilities, marketing, etc. However, direct costs (COGS) are not a part of this category.
Interest payments add up, so keeping track of all the interest payments a business makes on outstanding loans is crucial.
Depreciation and amortisation
Over time, significant assets like equipment or vehicles depreciate or lose their value. Expensing from that decline in value is important to note in your P&L statement.
Keeping track of taxes expected to be paid at the end of the year should always be noted.
Otherwise known as the "bottom line," the net profit is the number you get when you subtract all these categories from your revenue, or "top line." Occasionally, a business spends more than it earns, producing a loss instead.
Limitations of P&L statements
While successfully tracking your profit and loss statement is a key factor to financial success, there are limitations to what it can tell you, and other components are just as crucial. While a P&L report will provide insight into the bottom line, it won't tell you if the business is building stock but running out of cash.
Ultimately, this is why it's essential to keep an updated balance sheet and cashflow statement as you track your P&L account. With accurate numbers and consistent tracking, these 3 reports should help you keep on top of your company's financial wealth.
How to prepare a P&L statement
The hardest part of any task is getting started. Here is how to prepare a P&L statement.
1. Keep transaction records
Keeping meticulous records of your transactions is essential for accurate reports. Accounting software can provide tremendous value in these circumstances, as it can not only be used to record transactions but saves you time and, most importantly, mitigates human error.
Alternatively, you could hire a professional like a bookkeeper or accountant.
2. Choose a time period
When preparing your business profit and loss statement, decide which time period you want to assess. For the following steps to make sense and provide an accurate view of your business, the time frame needs to be consistent. Some P&L reports cover a month, others a quarter, and sometimes a full year.
3. Calculate your revenue
Determining revenue will depend on the total amount of money your business has earned. Generally, revenue reflects the sales of goods, products, or services.
4. Calculate your expenses
Now calculate every item the organisation has spent on business expenses during the determined amount of time.
5. Calculate your profit
Subtracting your expenses from your revenue should provide you with an accurate picture of profit. Further, your net income can be determined by then subtracting your taxes.
Accuracy is critical, and if human error is not your strong suit, specialised accounting software to automatically calculate profits could provide significant value— and may even save you money come tax season.
Automatically generate P&L statements with MYOB
For those who prefer to focus on their business and leave the numbers to the experts, MYOB's online accounting software could provide enormous savings, possibly giving you back your time and money to spend on more critical parts of your business.
The software automates tedious, everyday tasks, providing tremendous insight into your financial health and making compliance easy. MYOB lets you add your logo and branding to customisable invoice templates, allowing your organisation's individuality to shine through. MYOB keeps you prepared at a moment's notice, whether you're heading into a client meeting or tax season.
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