A simple profit and loss statement is a staple in almost any business.
The purpose of this document (otherwise known as a P&L statement) is to provide a highly detailed breakdown of revenues and expenses.
To be more specific, the P&L statement provides information on a company’s overall net income and the money spent during a specific period.
From bookkeepers, business start-ups, CEOs, and large accounting firms, the P&L statement has a popular standing for being one of an organization’s most critical financial documents.
For instance, companies use this document to see how much net income was made last year and forecast future revenues based on current expenses.
Additionally, businesses look at their projected net income throughout the year and compare actual results with their numbers to see how well they are doing financially.
The Times When You’ll Be Creating A Profit And Loss Statement
A few reasons exist for when you should prepare a profit and loss statement. The P&L statement is an effective way to:
- Present Company Performance – If your company is up-and-coming and looking to receive financing from a bank or venture capitalists, the profit and loss statement is an excellent way to show them how well your company has done financially.
- Forecast Company’s Future – If you are wondering how much money the business will make during a specific period, such as the next year, look at previous years’ results and then use these numbers to forecast the future.
- Keep Track of Expenses – One of the most important reasons to create a profit and loss statement is to stay on top of your company’s expenses.
- Gain Financial Information About Your Company – After compiling information from past projects, you can use this data in the present to help forecast future earnings as well as determine which strategies are effective and which are not.
- Determine Areas of Improvement – After reviewing your company’s performance, you will be able to determine areas of improvement and see which strategies from the past are working effectively for you in the present.
- Avoid Financial Disasters – Looking at a P&L statement can help you decide whether your company’s overhead is too high or whether you are making enough money to survive.
For those who feel intimidated by this statement or do not know where to begin, here’s a straightforward 10-step process:
Step 1 – Define the period for which you will be creating your statement.
If your company is a business structured as a corporation, your operating period will be different from if your company is structured as an LLC.
Those who run the business as a partnership or sole proprietor may have to use their financial records along with an estimated cash flow breakdown for the next year to predict future numbers.
If you plan to forecast performance, make sure you define the period for which this data applies.
Step 2 – Calculate your company’s revenue.
Also known as sales, revenue is how much money your company has made during a specific period.
When calculating this figure, make sure you include all the products or services sold over that specific period. For instance, if you are a service-based business such as an accounting firm, be sure to count each consultation and each hour spent on that project as revenue.
If you’re a product-based company, like in manufacturing, it is important to include all the amounts due from sales of products in your calculation. Before calculating the revenue for each period, you must create an itemized list of everything sold during that specific period.
Step 3 – Create a breakdown of the transactions that transpired during the specified period.
A breakdown of business transactions is a critical component of your profit and loss statement. These transactions include those of income as well as expenses.
Income includes the total amount received from all sales made during the specified period. This typically comes in a lump sum, not per transaction or project.
Expenses include any money used in conducting business for that specific period. It is important to remember that you can have both periodic and non-periodic expenses.
Periodic expenses occur for certain periods, month-to-month or year to year; these numbers are entered into the calculation according to how often they recur. For instance, if you pay a bill once per week, you will count each payment individually even though it is paid in one lump sum.
Non-periodic expenses recur only once during a specific period and then never again, such as the cost of equipment or initial start-up costs.
Step 4 – Compute the cost of goods sold.
The cost of goods sold is a figure that shows the sales price to you minus any expenses associated with creating or distributing your products.
To calculate this number, add up the purchase price for all items sold and subtract from this amount any discounts received and other costs associated with creating and selling these products.
Step 5 – Subtract the “cost of goods sold” from your revenue to get the figures for gross profit.
The gross profit is your revenue minus the cost of goods sold. This figure will tell you how much money you earned or lost on each sale and is one of the most important figures for analyzing a company’s performance. It’s why it must be part of your profit and loss statement.
Step 6 – Determine the operating expenses.
Operating expenses are the costs associated with running the business itself during a specific period. The items considered “operating expenses” include rent, equipment, marketing costs, employee salaries (payroll), and others. Keep in mind that all operating expenses must have a direct correlation with conducting business.
Step 7 – Compute the “operating profit” by subtracting the operating expenses from the gross profit.
The operating profit is your company’s revenue minus all expenses associated with running and maintaining this business. You must figure this number out to understand if you have a total operating profit or loss.
Step 8 – Incorporate your business’s “additional income” into your operating profit.
Additional income is any money received in a certain period beyond normal operating expenses. This can occur through the sale of equipment, investment returns, or even profits made by other companies that you own.
When figuring this number out, don’t forget to add all amounts received during the specified period into your calculation.
Step 9 – Calculate other essential figures, i.e., taxes, depreciation, interests, and amortization.
Your profit and loss statement can only be accurate if you figure out any other expenses. You must trace these numbers back to the related figures for assets and expenses in your balance sheet.
Depreciation is an expense that reduces the value of certain business assets over time, while amortization does essentially the same thing except it relates only to intangible assets such as patents or company trademarks.
When calculating these figures, ensure that you’re using the right rate for each asset being depreciated or amortized. The depreciation tax laws change from year to year and from state to state, so make sure you know what the current tax rates are before applying them to your business.
Step 10 – Subtract these expenses from your “operating profit” to determine the bottom line or net profit.
The “bottom line” is the net income for a specified period. All you must do is subtract all additional operating expenses and taxes and interest fees paid by the company during that time to get your final number.
This number represents or is indicative of how well your company is doing.
There’s no one-size-fits-all template in making a profit and loss statement. As you create your very first statement for your company, remember that it must be tailored to the specific business that you run.
That being said, every “profit and loss statement” has a fixed structure that includes your company’s revenues, operating expenses, depreciation, amortization, tax, and the bottom-line income or net profit. Without any of these numbers in hand, you can’t draw a clear image of how well your business or company is doing.