If you are new to accounting or business, you might be wondering what a profit and loss statement is and how to make one. A profit and loss statement might seem complicated at first, but it can be easily understood using the information in this article.
A profit and loss statement is also referred to as a P&L. It’s a financial statement that presents your business income and expenses over a certain period of time. You might also hear it called an income statement or a statement of operations.
Your profit and loss report can show your company’s profits because it subtracts all your business expenses from the income. These statements show business owners how their business is doing financially and provide reliable financial documents to attest to the financial health of their company.
Formula for a Profit and Loss Statement
The profit and loss statement shows your revenue minus the expenses and can be encapsulated into the following formula:
Revenue-Expenses= Net Profit (Net Loss)
This crucial document for your enterprise allows you to familiarize yourself with your business profit and losses and is a reflection of your financial transactions. It can become a valuable tool for business owners who want to make informed business decisions, avoid business debt, or prepare for a business loan. The profit and loss statements can be annual reports, although some companies prefer to study their financial report weekly, monthly, or quarterly.
What Will I See On My Profit and Loss Statement?
You and your accountant will go over your earnings and expense statement together to assess your profit and loss for the reporting period. The statement will also show you how to better manage your profits better and where you might be able to cut costs to improve your company revenue.
It will also encourage you to see where your revenue is coming from, as well as highlight your cash flow and expense trends. You will then be able to change your budget and resources as needed to make your company profitable.
The profit and loss reports are mandatory for private companies and required by the IRS because they show your business profits for tax purposes.
Parts of a Profit and Loss Statement and Their Definitions
To make it easier for you to understand the terminology associated with the profit and loss statement, we put together a list of the most popular terms and definitions used in business accounting.
- Net Profit: total amount earned after you have deducted your expenses. You can subtract the total expenses from the gross profit.
- Operating Income: the earnings you have before taxes and interest. Calculate it by deducting operating expenses from the gross profit.
- Gross Profit: also listed as gross income or gross margin. It’s the net revenue without the costs of sales.
- Cost of Goods Sold: the cost of services and products.
- Revenue: the net sales during a specific accounting period. It includes the revenue earned from the primary business activity.
- Operating Expenses: the selling, general, and administrative expenses incurred by your business. They can include payroll, utilities, and rental expenses. Non-cash expenses are also included.
- Other Income and Expenses: expenses and income not related to normal operations. They can be gains and losses from the sale of long-term assets or they might be infrequent revenues.
Calculating Profit
If you want to find the net profit or loss of your company, you can do so by using the following equations:
- Net Profit (or Loss)= Net Profit before Taxes-Income Taxes
- Net Profit before Taxes= Net Operating Profit + Other Income-Other Expense
- Net Operating Profit= Gross Profit – Operating Expense
- Gross Profit = Net Sales – Cost of Sales
How Can I Write a Profit and Loss Statement?
Writing a profit and loss statement is easy when you use an accounting method. There are two basic ways to create a profit and loss report manually.
Single-Step Method
This method is better for small businesses or businesses that are service-based. It uses a single subtotal for the expense items, so it’s pretty easy to use. The net gain will be at the bottom of the report. The only downside to this method is that it does not provide a breakdown by department. It also does not have gross margin calculations.
It’s called a single-step method because it only uses a single subtotal for all the expense items and the revenue line items.
Multiple-Step Method
This is an alternative method of accounting, more detailed than the first and a little more complicated to use. It will help you calculate your net operating income by separating the operating expenses from the operating revenue. The method is often used by enterprises with complex business operations because they want to have more information regarding their core operations and the profits coming from them.
For the multi-step method, you will actually be using three steps. Do the following:
- For the gross profit, subtract the cost of the goods sold from your net sales.
- Operating income is calculated by subtracting your operating expenses from your gross profit.
- For non-operating revenues and gains, as well as non-operating expenses, subtract them from the operating income. This will give you the net income.
Both methods will work if you want to manually create a profit and loss statement. However, many businesses choose to use online software instead because it saves them time and allows them to concentrate on other aspects of their business.
For online accounting software, as well as professional profit and loss statements, you can contact a professional accountant who is trained to provide the financial documents and prepare your taxes.
Final Thoughts
Profit and loss statements do not have to be complicated as long as you have all the necessary information and access to the formulas mentioned above. Although making your own reports is not a difficult task, using online software may be a better option if you want to ensure a high level of accuracy and save a lot of time. Furthermore, accounting services can make the statements much easier to understand.
