Understanding a profit and loss (P&L) statement

A profit and loss statement, or “P&L”, is an effective tool for managing your business. It is a financial statement that provides a snapshot of how much your company is making (revenue) compared to how much is being spent (costs and expenses). Simply put, your P&L shows your business’s revenue minus costs and expenses, typically over a specified period. The outcome is your net profit or bottom line.

Business owners and management use this information to analyze the financial health of the company. For example, is it profitable? Are costs reasonable? Are enough sales being generated?

Profit and loss compared to other financial statements

The P&L, also referred to as the income statement or statement of revenue and expense, is typically used alongside other key financial reports like the balance sheet and cash flow statement to determine the health of a business.

• The balance sheet, or statement of assets, shows the financial position of a business by detailing assets, liabilities and equity held at a specific point in time. In other words, it provides an overview of what the business owns and how much it owes.
• The cash flow statement shows how much cash a company is generating or spending over a specific period. This is shown by viewing the business’s operating, investing and financing activities, which provides a view of how the company generates and manages cash.

Types of profit and loss statements

Two common accounting methods are the cash basis and the accrual basis. These accounting methods result in different types of P&L statements.

• The cash method statement is the simplest. When money comes into the business, it is recorded as revenue. When money is used to pay for something like bills or payroll, it is recorded as an expense.
• The accrual method statement records income as it is earned instead of when cash comes in the door. If you invoice a client using the accrual method, you will account for that income when you perform the service or deliver the product, not when the customer pays. Similarly, expenses are recorded when incurred.

How to create a profit and loss statement

If you use an accounting software, creating a P&L is as simple as a few clicks of the mouse. That said, understanding what goes into creating one is essential.

Here are the steps:

1. List revenue (sales): Choose a timeframe for the statement and then list all income from all sources for that period.
2. List variable costs or Cost of Goods Sold (COGS): COGS applies to product-based businesses. It is the actual cost of producing and selling that product. (Cost of services, or COS, is the same thing but for a service business.) Here you would list all costs associated with obtaining and selling your products or service.
3. Subtract costs from revenue: This is your gross profit.
4. List fixed costs or operating expenses: Things like rent, utilities and payroll.
5. Subtract operating expenses from gross profit: This is your operating profit.
6. Add in additional income, not from regular operations: Add in income from other sources, such as dividends or interest paid to you. This is known as EBITDA – Earnings before interest, taxes, depreciation and amortization.
7. List any interest, taxes, depreciation and amortization.
8. Subtract interest, taxes, depreciation and amortization from EBITDA: This is your net profit (or bottom line).

Once complete, your P&L can provide valuable insights. For example, which products, services and revenue streams are paying off and which are lagging? Did that marketing plan for the new store work? Look at the sales numbers for the new store and see. It also gives you a bird’s-eye view of where your business truly is financially, as opposed to where you think it is. While you may have an intuition – and even some facts – that your labor costs, for example, are too high, your P&L can tell you for sure.