What Is A Profit And Loss Statement?

What is a P&L Statement?

A P&L statement is a document that compares the total income of a business against its debt and expenses. A P&L statement is an indicator of the financial health of your company based on its ability to generate income through sales, manage expenses and sustain a healthy profit margin. Some P&L statements are very simple while others are extremely complex. 

Net income and operating income

Before we dive into the basics of understanding, creating and using a P&L statement, there are two key terms you should know: operating income and net income.

“Operating income” refers to the income your company makes after its operational expenses are deducted. This is useful for understanding the overall strength of a company’s core operations, although it doesn’t include additional expenses so it isn’t a clear view of a business’s actual profitability.

“Net income” refers to your income after additional, nonoperational expenses like taxes and interest on debt are deducted. It may also include any income you derive from interest on loans or the sale of assets like equipment or real estate. 

Why is preparing a P&L statement important?

P&L statements are important because they help measure a business’s success, enabling leadership to make more informed decisions. With a P&L statement in hand, management can determine which activities are generating a return on investment and which are losing money and then acting accordingly.

You will also need to furnish a P&L if you are applying for a small business loan or if you’re seeking funding from investors. Lenders and investors will evaluate your net income and operating income against the expenses, debts and taxes to ensure your business is viable and worth providing financial assistance to.

Many companies are also required by law or association membership to complete P&L statements, making them an important document to regularly create to ensure regulatory compliance.

What are the components of a P&L statement?

The first thing that typically appears on a P&L statement is total income, which is the gross revenue for a business throughout a certain period. This may be divided by site for businesses with multiple locations. 

Next, a P&L statement usually includes the total cost of goods sold (COGS), which is subtracted from revenue to determine operating income. The COGS, or operating expenses, can include inventory, wages and salaries, professional fees and other expenses necessary to running your business. These are usually itemized on a P&L statement. 

Next, any nonoperating expenses, such as interest on loans or taxes, are deducted from the operating income to determine net income or net profit. These expenses are kept separate on a P&L to contrast them from expenses that relate directly to sales and revenue, as well as to make determining tax deductions easier.

A P&L typically is prepared around tax time, but it may be used in a few other instances, such as to inform the business owner, employees and shareholders of a company’s performance, secure funding or as proof of income if the business is sold.

Who prepares a P&L statement?

Most business owners hire a bookkeeper or an accountant to complete a P&L statement, which is advisable since professionals have the expertise to ensure everything is prepared accurately. If you are more focused on other aspects of your business, it is perfectly acceptable to hire an outside expert to create a P&L statement for your business.

However, although a P&L statement is one of the more complicated bookkeeping practices of a business, with some knowledge and practice, you can do it yourself. There are also many types of software available to help you complete your P&L statement should you choose to go it alone.

How do you analyze a P&L statement?

When analyzing a P&L statement, pay close attention to net income, operating income and the expenses and depreciation for the business. You may have heard the term “bottom line,” which in everyday conversation means the net profit, the final indicator of a business’s overall health.

It’s important to understand where net profit (or net loss) comes from by reviewing expenses. For example, if your operational income appears strong but debt service payments are eating into your profit margin, it may be an indicator that your business is over-leveraged and has too much debt on its books. Similarly, if the growth of wages and salaries are outpacing revenue, it could be a sign you’re hiring too quickly.

What is the difference between a P&L statement and a statement of revenue?

A statement of revenue includes only the income data for a company, while a P&L statement compares income to expenses. Technically, a statement of revenue could be a section of your P&L statement. 

Often, a statement of revenue is used as an early indicator of whether the company is generating income, which is especially important for startups to demonstrate to lenders and investors. Many banks and investors, though, will eventually want to see a complete P&L statement.

Understanding the P&L statement is key to running a successful business or project

The P&L statement provides a quick snapshot of how your company is performing financially. Regularly creating and analyzing a P&L statement can help you better understand how your business is performing, which expenses are generating a return on investment and which are eating into profits. As the saying goes: “Knowing is half the battle.” Knowing where you stand through accurate P&L reporting can mean the difference between success and failure for any small business.