Not a lot of small business owners really pay much attention to accounting. But learning the basic principles of accounting can be the key differentiator between a company that is successful and one that is not. P&L, the Profit and Loss Statement is a basic accounting report for any type of business.
In that light, let’s delve a little into the world of accounting. The aim of this article is to let you know what is P&L, how to make a profit and loss statement as well as every other thing that surrounds it.
What is a Profit and Loss (P&L) Statement?
The profit and loss (P&L) statement is a financial report summarizing a company’s net revenue and total expenditures for a particular period. The period is usually, a month, a quarter, or a year. It is also referred to as an income statement or the statement of operations.
This video explains the P&L Statement.
When do I need to prepare a Profit and Loss Statement?
A simple Profit and loss statement is usually evaluated over the following common time frames:
- Monthly
- Quarterly, and
- Yearly
The simplicity and volume of any P&L account are highly dependent on the size of the business as some could be short and easy to understand while others can be complex. This means a profit and loss account for small businesses will be shorter and easier to comprehend than that of bigger companies.
What information do I need to prepare this statement?
Writing a simple Profit and loss statement or any other financial report for the first time can be a really challenging task as you’ll come in contact with some terms you’ve never seen before, so it would be great if you had a good knowledge of some common terms used if you want to create a Profit and Loss Statement. Now let’s look at a few of them.
- Revenue
A good Profit and Loss statement begins with an overview of sales revenue that occurred during the period in question. Revenue is the amount of money produced by the selling of products or services connected with the primary activities of the business.
It is often referred to as gross sales and the “top line” because it is at the top of the P&L statement.
- Expenditure
Expenditure is a payment for the purchase of goods or services using either cash or credit. This can be a general or an administrative expense that is accrued to run the business.
- Costs of goods sold (CoGS)
This is also called direct costs. They are expenses that can be attributed solely to the production or sale of a product or service.
- Gross Profit
Gross profit refers to the total revenue excluding direct costs. Mathematically, it is represented as
Gross Profit = Revenue — Direct Costs (CoGS)
The Gross margin, on the other hand, is represented as a percentage. Its formula is
Gross margin % = Gross Profit / Revenue
A primary measure of your company’s financial condition and the viability of your business model is the gross margin. The higher the proportion, the better.
Potential investors are going to zero in on this number quickly. This number also offers details on how competitive the organization is or will be in the near future.
- Depreciation
Over time, due to use, wear, and tear or obsolescence, the monetary value of an asset decreases. This reduction of value is calculated as depreciation.
- Operating expenses
This includes rental costs, salaries, utilities, and all other expenditures essential for the company to operate. Non-cash costs such as depreciation are also included.
- EBT (Earnings Before Tax)
EBT can be obtained by subtracting the cost of goods sold, operating expenses, and depreciation from the total revenue.
- EBIT (Earnings Before Interest and Tax)
It is usually found at the bottom of the statement. It represents total revenue, excluding the cost of goods sold and operating expenses.
- Net Income
Net income is the total amount earned after the costs have been deducted. To calculate this, you simply subtract the cumulative expenditures from the Gross Profit.
How to do a profit and loss statement?
Learning how to create a Profit and loss statement is not as difficult as you may think, and I’ll show you how to do that in 8 simple steps;
- Input Revenue: The number one step in making a P&L statement is to calculate all the profits earned by the business over a chosen period.
- Deduct the Cost of Goods Sold (CoGS).
- Calculate Gross Profit: Subtract the cost of goods sold from revenue to determine gross profit. Remember, gross profit refers to the total revenue excluding direct costs. Once you have calculated your income and the cost of goods sold, the next thing is to subtract the cost of goods sold to obtain the gross profit.
- Deduct operating expenses.
- Calculate operating Profit: Here, you subtract operating expenses from gross profit to obtain the operating profit.
- Add additional income to your operating Profit: Additional income such as interests from Investments can be added.
- Deduct interest, taxes, and depreciation.
- Calculate net income: finally, you calculate the net income by subtracting expenditure, taxes, and depreciation for the gross profit.
A Simple Profit and Loss Account
| Total revenue | 1,000,000 |
| Cost of Goods Sold | 400,200 |
| Gross Profit | 599,800 |
| Less Expenses: | |
| Accounting and legal fees | 11,500 |
| Depreciation | 30,000 |
| Advertising | 10,000 |
| Workers compensation | 6,500 |
| Wages and salaries | 150,000 |
| Vehicle operating costs | 10,000 |
| Training & seminar | 6,900 |
| Maintenance | 21,000 |
| Stationary | 2,000 |
| Rent | 50,000 |
| Printing | 22,000 |
| Electricity | 2,500 |
| Interest and bank charges | 110,900 |
| Insurance | 120,000 |
| All other expenses | 14,100 |
| Total Expenses | 459,500 |
| Net Profit | 140,300 |
FAQs
In as much as accounting, in general, might not be everyone’s forte, you cannot downplay its importance as it’s very important for any business to thrive, and it’s the same with the P&L Statement. A simple profit and loss come with a lot of advantages, and we’ll look at some of them now.
The most obvious one is that a P&L Statement helps you to know if your business is thriving. A good P&L Statement before doing any other things tells you whether you’re making a profit or not, and I’m sure you’d want to know the state of your business, so to do that, you should write a simple P&L Statement, and according to the U.S Small Business Administration, it is the “perfect tool to know if your business is profitable.”
In addition, a profit and loss (P&L) statement may also be a valuable method to build a budget or measure the working capital of the business.
Another purpose for generating a profit and loss statement is that the IRS (Internal Revenue Service) can request for it to calculate taxes on the company’s income.
Also, a good Profit and loss statement can serve as a requirement for obtaining loans and grants. Today, banks, investors, and business angels don’t just give money to just anyone. A well-prepared and presented P&L Statement could give you that extra edge in securing that business loan or grant as the case may be.
Above all, a simple P&L Statement can assist you to make educated decisions such as:
– How are you going to organize your taxes?
– Can you afford to hire extra staff?
– Can you move your business to a larger office?
– Should you move your business elsewhere?
– Is your established growth strategy efficient?
Reading a well-prepared P&L statement can be very straightforward. You begin with a summary of your revenue, clear records of your costs and expenses, and then show your net profit, which is the all-important “bottom line.” So, if you want to know if your business has been profitable, you simply look up the net profit.
An audited P&L statement is a financial document that has been reviewed by an external body to ensure that the recorded profit and loss items are consistent with the company’s supporting transaction records and that the profit & loss statement in question uses consistent accounting procedures relative to previous years.
Profit and loss reports do not contain financial items that are typically listed on the balance sheet, such as bank loans or large asset transactions.
There’s no difference between a Profit and loss account and an income statement. They are basically the same.
As stated earlier in the article, items that should be on your profit and loss account include revenue, gross profit, net profit, expenditure, running expenses, gross margin, gross margin percentage, etc.
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Conclusion
The need for a profit and loss statement can be overemphasized as it’s an effective tool for both small and large businesses to determine whether their business is profitable or not. It provides a clear picture of the current state of the business, and the areas of improvement to get the maximum returns.