Running a small business means keeping track of your finances. One important financial document you need to understand is your Profit and Loss (P&L) Statement, also called an income statement. This statement shows whether your business is making a profit or running at a loss over a period of time, such as a month, quarter, or even year.
Knowing your P&L statement can assist you in making better business decisions, reducing unnecessary costs, and expanding your business in the right direction. In this article, we will break down how to read and interpret a profit and loss statement.
What is a Profit and Loss Statement?
- The amount of money that your business made, which is revenue.
- The amount of money that your business has spent on expenses.
- What is left over is the net profit or net loss.
- The Major Sections of a P&L Statement
The following are the important sections of a profit and loss statement and what they mean:
Revenue
These are net sales during the accounting period; this includes revenue from the main business activities and other activities.
Cost of Goods Sold (COGS)
It is the cost of producing the products of the business or delivering its services. This includes labour, materials, transportation, and other costs.
Gross Profit
It is also known as gross income or gross margin. This is calculated as net revenue minus the cost of goods sold.
Operating Expenses
These include the costs of operating the business: variable costs such as labour, supplies, and payroll; fixed costs like rent, accrued expenses incurred but not yet billed; and non-cash expenses such as depreciation.
Operating Income
This is the income before taxes, depreciation, interest, and authorisation. It is calculated by subtracting the operating expenses from gross profit.
Other Income and Expenses
This accounts for one-off or infrequent income and expenses that are not related to the regular business operations. This may include revenue from the sale of company assets or the cost of repairs.
Net Profit
As the bottom line of the profit and loss statement, this is the total amount earned after deducting expenses, calculated as gross profit minus total expenses.
The Importance of a Profit and Loss Statement
A P&L plays an important role in decision-making by showing whether your business is heading in the right direction. Are you earning more than you spend? It also gives support in budgeting by helping you plan your spending and manage your cash flow more effectively. When you are applying for loans, this statement is often required by banks and investors to assess your financial health. Also, it provides accurate figures for business income and expenses, which are essential for tax filing.
How to Create a Profit and Loss Statement
Now that you understand what a P&L statement is and what the types are, let’s take a look at how to make one.
A simple yet complete version of a profit and loss statement involves the following steps.
Choose a reporting period: Oftentimes, by law, companies are required to produce a P&L statement at the end of each fiscal year. However, some companies choose to report profits and losses quarterly or bi-annually.
Gather data covering revenue and expenses: Collect your data from your accounting tool regarding company revenue streams and a detailed list of expenses so you can prepare each line entry.
Total revenue: Sum up your total revenue from each applicable channel.
List your cost of goods sold: List your COGS data into individual entries to maximise the visibility of the cost breakdown.
List your expenses: List your other overhead business expenses in additional line entries.
Determine your net income: Based on everything listed above, conduct the simple equation to determine your company’s net income.
Your P&L statement is not just a bunch of numbers; it is a story of the performance of your business. By checking it regularly, you will be able to catch problems in time, make changes to your strategy, and remain on track towards growth.
Even if you work with an accountant, it’s important to understand your P&L so you can make informed decisions. This knowledge will help you grow a profitable and sustainable SME better.
