What is a profit and loss statement?

A Profit and Loss Statement, also known as a P&L Statement, is a financial document that summarises the revenues, expenses, and costs incurred by a company during a specified period, typically a fiscal quarter or year. Its purpose is to provide valuable insights into a company’s ability to generate profits by either increasing revenue, reducing costs, or both. The other two essential financial documents that companies are required to publish quarterly and annually are the balance sheet and cash-flow statement. While the P&L statement and cash-flow statement are similar, the balance sheet differs as it shows what a company owes and owns at a specific moment in time. Many people mistakenly believe that P&L statements and balance sheets are the same, but there are several differences between them:

• The purpose of each report is quite distinct. For example, P&L statements are more specific asking if the company is even profitable? Whereas balance sheets are broader and reveal what the company owns and owes.
• A balance sheet tells the financial position of a company for one specific point in time whereas a P&L statement or sheet shows revenues and expenses during a set period of time.

Not familiar with the concept of a balance sheet? Check out our comprehensive blog post titled “What is a Balance Sheet?” for a detailed explanation.

There are two ways to complete a profit and loss statement: use accounting tools like Xero, or do it manually with software like Excel.

We recommend cloud-based accounting software like Xero, which allows users to audit or create Profit and Loss statements quickly, as most of the calculations are automated from receipts and invoices, so it’s less likely for anything to be overlooked or miscalculated.

Plus, software tools often offer various statement formats like bar charts and line graphs, making it easier to see trends and make business decisions.

But regardless of how you compile it, there are six key areas to include in a Profit and Loss statement:

1. Revenue
2. Cost of goods sold (COGs)
3. Gross profit (or loss)
4. Operating expenses
5. Operating Profit
6. Other Income and Expenses
7. Net profit (or loss)

The revenue section of a profit and loss statement includes all the income your business receives from day-to-day operations.

This covers the sale of goods and services, and other sources of income, such as the disposal of used office supplies.

Before calculating your total income, determine the time frame you’re calculating for. If it’s quarterly, then add all the sales generated during those three months to get accurate revenue figures.

For example, if your business reeled in:

• January: $5.7k
• February: $10.3k
• March: $3.5k

Then your total net sales is $19.5k.

The cost of goods sold or COGS are direct expenses or amount spent to produce products or deliver services to clients including labour and materials. For example, purchasing sand and cement to lay bricks or machinery to complete a job for customers.

You don’t put in expenses like (e.g. rent, accounting, and marketing) that are not expressly associated with the creation of services and goods that are not part of COGS. These fall under additional expenses or operating costs.

For this example, suppose the COGS is $5.5k.

Gross profit is how much a business earns after subtracting COGs. The formula:

Revenue – COGS = Gross Profit

So in this scenario:

$19.5k Revenue – $5.5k COGS = $14k Gross Profit

Under this bucket, operation expenses are administrative, general and selling expenses related to running and maintaining the business operations. This includes spending for:

• Employee salaries
• Business rent and utilities (business phone, office or factory space, etc.)
• Depreciation of company equipment (computers, office furniture, vehicles, etc.)
• Administrative fees (insurance, office supplies, and other items not directly connected to specific goods or functions)

Add everything together to get a total. Say, in this example, the amount comes out to $2.2k.

Operating profit is the total your business gets after deducting COGS and additional expenses. You’ll need to calculate your gross profit, minus what you spent on rent, salaries, admin fees, etc.

The formula:

(Revenue – COGS) – Operating Costs = Operating Profit

So in this example:

($19.5k – $5.5k) = $14k Gross Profit

$14k – $2.2k Operating Costs = $11.8k Operating Profit

The operating profit is $11.8k, and the total expenses are $7.7k (COGS + Operating Costs).

While not required, sometimes breaking out certain revenue and expenses into separate sections of Profit and Loss can help with understanding reports.

This section can include income or expenses that aren’t related to normal operations, such as sales of company assets, interest, dividends, government grants etc.

Net profit is the amount your business earned minus COGS, operating costs, debt interest, and taxes. In other words, it’s the total revenue minus all costs, and signifies what eventually ends up in the company’s account.

To calculate, take your operating profit and subtract taxes and interest from debts (e.g., business lines of credit, loans). The formula:

Operating Profit – (Debt Interest + Taxes) = Net Profit

So if the total for debt interest and taxes is $4k in this example:

$11.8k Operating Profit – $4k Debts and Taxes = $7.8k Net Profit

If your total was negative, you’d have a net loss instead of a net profit.

Create performance benchmarks

Review P&L trends to set benchmarks and identify gaps in business performance. Collaborate with your team or financial professional to improve areas with significant differences from desired values.

Monitor cost increases

Managing your profit and loss statement provides the advantage of easily identifying patterns or variations in vendor or supply costs. It is important to monitor any consistent cost increases and investigate them further, as prices may change over time. It can also be helpful to obtain additional information regarding irregular expenses, such as changes in recurring fees.

Evaluate the use of resources

Unused or under-utilised resources can lead to financial losses. Explore new ways to use them or redirect funds to more valuable initiatives. Create a plan to maximise return on investment through efficient resource allocation.

Advantages of a Profit and Loss Statement:

Tracks business performance: the “bottom line” is a key indicator for a business’s financial health and can be used to compare past periods.

Identifies financial trends: past statements can help forecast future performance and detect issues early on.

Disadvantages of a Profit and Loss Statement:

Limited view: relying solely on P&L statements can be risky as other financial documents like balance sheets and cash-flow statements are equally important to assess a business’s health.

Time-consuming: P&L statements require a significant amount of financial reporting and excessive focus on them can lead to an unrealistic view of the business’s financial position.

As a business owner, it is crucial to pay attention to your business’ profits and losses to ensure long-term growth and success. Accurately tracking your financials allows you to identify areas for improvement, make informed decisions, and allocate resources effectively.

To streamline the process of financial reporting and enhance the accuracy of your profit and loss statements, consider using software tools designed specifically for accounting and bookkeeping. These tools can automate repetitive tasks, reduce human error, and provide valuable insights into your company’s financial performance.

Furthermore, when it comes to seeking investments or selling your business, the profit and loss statement is one of the most important documents potential buyers or investors will consider. A clear and concise profit and loss statement can demonstrate your business’s profitability, cash flow, and overall financial health, providing confidence and transparency to interested parties.

In conclusion, keeping a watchful eye on your profit and loss statements is essential for business growth and success. By leveraging technology and seeking professional guidance (Gecko Bookkeeping), you can enhance your financial reporting and position your business for future growth opportunities.