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How to make a profit and loss statement

Sunday, January 19, 2014

A key financial statement for small businesses

Measuring how your business is performing is a key component of running your business. From knowing how you’re doing with customers and their thoughts on your business to the facts and figures of bookkeeping, measurement is crucial to your success. One of the ways a small business owner like you can measure their financial performance and progress is through a profit and loss (P&L) statement. This statement can be valuable for your company, whether you’re a small business or a large corporation. So, in this article, we’ll learn about P&L statements, including the ins and outs of calculating them and how to create one for your business. First, let’s define a P&L statement.

What is a profit and loss statement?

A P&L statement is a financial document that gives you a look at pertinent business information, taking into account all of your company’s revenue and expenses for a specific period of time. This financial report is sometimes referred to as an income statement or a statement of operations in the accounting world. Depending on how your business operates and what business frameworks are in place, a business P&L statement can encompass weeks, months, or the entire year. It’s important to note that a P&L statement is one of many financial reports – including balance sheets and cash flow statements.

So what does a P&L statement show? Well, it’s a way for a business owner, potential investors, accountants, and others to evaluate the financial health of a business. It can help you manage your profits by seeing where you may be able to cut costs to streamline operations. This statement can also help you examine revenue and expenses, see cash flow and net income, calculate your operating costs, and evaluate your company’s profitability. Having a better understanding of these numbers can help you adjust budgets and staffing appropriately. When it comes to business finances, there’s no requirement to show your P&L statement to the Internal Revenue Service (IRS) for income tax purposes. However, a tax return is essentially a version of a P&L statement.

When it comes to a business financial statement, you may wonder about balance sheets. And while these are important because they show all of your financial assets and liabilities, the P&L statement is largely seen as more important. That’s because the P&L shows the company’s ability to make a profit. Now that you understand the importance of a P&L statement for your business, let’s figure out how to construct a P&L statement.

How to create a profit and loss statement

Making a P&L statement for your business isn’t difficult. In fact, it’s fairly straightforward and can help signify your business performance. Let’s take a step-by-step look at how to formulate a P&L statement.

Step 1: Calculate revenue

To start with a P&L report, the first step is to calculate all of the total revenue your company generates. Sometimes, this calculation is considered to be total sales, gross receipts, fees, or operating revenue. Usually, you’d separate revenue from other sources of income. These payments can come from a variety of sources – ACH transfers, wire transfers, checks, and credit cards.

It’s important to note that your company’s accounting method affects when you report revenue. If you use the accrual method, you’ll report revenue when you earn it, even if you haven’t received payment yet. In contrast, if you use the cash method of accounting, you’ll record your revenue when you receive payment. You can also ensure accurate revenue calculations by adjusting gross sales by any customer returns or refunds. These would go against your sales to find a net revenue.

Step 2: Calculate cost of goods sold

The second step is to calculate the cost of goods sold. The cost of goods sold is your cost of purchasing or making the goods your company sells. For instance, if you make t-shirts, your cost of goods sold would include the expenses you have to either make the t-shirts (blank t-shirts, any printing costs, etc) or to buy the t-shirts from the manufacturer.

Step 3: Calculate your gross profit

The third step is to calculate your gross profit. You do this by subtracting your cost of goods sold from your revenue.

Revenue - cost of goods sold = gross profit

For instance, if you had a total of $100,000 in sales and you had a total of $30,000 in cost of goods sold, your gross profit would be $70,000 ($100,000-$30,000).

Step 4: Calculate operating expenses

Once you have gross profit, the next thing you’ll do is calculate operating expenses. Operating expenses are any expenses you incur as a result of running your business. Quite simply, they’re the cost of keeping your business running. Often, you’ll divide these expenses into buckets or line items. Some of these categories include:

  • Advertising costs
  • Employee salaries, benefits, and payroll taxes
  • Interest expenses
  • Office supplies
  • Payments to vendors or contractors
  • Professional fees for accountants, attorneys, etc.
  • Rent
  • Repairs
  • Utilities
  • Postage
  • Printing
  • Travel costs

As you’re accounting for these expenses, you’ll need to understand depreciation or work with an accounting professional who understands depreciation of assets. Some assets can be written off over the life of the asset, while others can be fully included in the operating expenses in the year in which the item was purchased. After you figure out all of these costs, you’ll add them together to get your total operating expenses.

Step 5: Subtract operating expenses from gross profit to obtain operating profit

Next, you’ll subtract the total amount of these operating expenses from your gross profit. The number you arrive at is known as the operating profit. Another term for operating profit is operating income. For all intents and purposes, they’re the same thing.

Gross profit - operating expenses = operating profit or operating income

Step 6: Add additional income to your operating profit

As we mentioned, you may have additional income from things like interest or dividend income, sales of long-term assets, and other infrequent or irregular income sources. You’ll add this additional income to your operating profit to get your total earnings before interest, taxes, depreciation, and amortization (EBITDA).

Operating profit + additional income = EBITDA

Step 7: Calculate interest, taxes, depreciation, and amortization

The second to last step is to calculate any interest payments, taxes due, as well as depreciation and amortization expenses. Once you calculate this, you’re one step away from a final P&L number.

Step 8: Subtract interest, taxes, depreciation, and amortization expenses from EBITDA to obtain net profit

In this very last step, you’ll subtract the amount you came up with in Step 7 from the EBITDA to find your company’s net profit for the given time period.

EBITDA - interest, taxes, depreciation, and amortization = net profit

To illustrate these steps, let’s walk through an example of how a business owner would make a profit and loss statement.

Profit and loss statement example

To walk through a P&L statement, we’ll look at a basic example. Again, this is meant to simply illustrate each of the steps. For this example, let’s assume that Marie makes cinnamon rolls at her house and delivers them. In her first year of business, she made a total of $10,000. The total she spent on ingredients was $1,500. She also had expenses that included pans for delivery, car expenses, advertising, and insurance costs. Here’s how to calculate Marie’s P&L.

Revenue = $10,000

COGS = $1,500

Gross profit = $8,500

Expenses

Pans = $250

Car = $600

Advertising = $500

Insurance = $2,000

Total expenses = $3,350

EBITDA = $5,150

Taxes (no loans or depreciation/amortization of assets) = $750

NET PROFIT = $4,400

Once we’ve calculated Marie’s net profit, we can calculate net profit margin. We simply divide net profit by revenue to get a percentage. Therefore, we’ll divide $4,400/$10,000, which turns out to be 44%. One benefit of making consistent P&L statements is that you can compare your company’s performance from period to period, year to year. That can give you key insights into how your business is performing compared to past periods.

As you can see, a P&L statement is a valuable financial tool for your business. The bottom line is that it can help you determine the financial health of your business and areas where you may be able to streamline and cut costs. It can also help show your company’s performance from year to year. Therefore, it’s really important to know how to make a P&L statement. After reading this article, you should be able to put together a P&L statement for your company. If you need help, you can look to an accountant, business accounting software, or other third party service providers to help you make sure everything is correct.


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