What is a profit and loss statement?
A profit and loss (P&L) statement details the revenue, expenses, and costs from a specific time period to show net profits. Also called an income statement, this financial report spells out whether a business is making a profit or losing money. It can help you understand what helps drive profitability in your business and also reveal potential financial issues.
Along with a balance sheet and a cash flow statement, a P&L statement is one of the three primary financial statements used to report on a company’s financial position and results of operations.
How profit and loss statements work
A profit and loss statement has six essential sections. Here’s how they work:
- Revenue. Profit and loss statements typically start with a revenue section, which includes income generated by primary business operations like sales revenue, service fees, and other sources of income.
- Cost of goods sold (COGS). If the business sells products, the cost of goods sold section reflects the direct costs associated with production or acquisition. It includes the cost of raw materials, manufacturing expenses, and direct labor costs.
- Gross profit. You can calculate this by subtracting the cost of goods sold from revenue. It represents profit generated from the core business operations before considering operating expenses.
- Operating expenses. This section includes the business expenses incurred from day-to-day operations. It consists of various categories, such as selling expenses, administrative expenses, research and development costs, marketing expenses, and more.
- Operating income. Operating income, also known as operating profit, is calculated by subtracting the total operating expenses from the gross profit. It reflects the profitability of the company’s core operations.
- Non-operating items. These items are revenues or expenses that aren’t directly related to the primary operations of the business. This may include interest income, interest expenses, gains or losses from investments, income taxes, and other similar items.
- Net income or net loss. The final section of the profit and loss statement calculates the net income or net loss of the business. You calculate this figure by subtracting non-operating items from operating income. If the total is positive, it represents the net profit—if negative, it represents a net loss.
Types of P&L statements
There are two ways to prepare a P&L: the cash accounting method and the accrual method.
The cash accounting method only looks at the cash that’s been received or paid. This approach is more common with smaller businesses.
The accrual method accounts for money that’s earned, even if it is not yet received. It also tracks expenses that have been accrued but not yet paid.
What does a profit and loss statement look like?
Here’s an example of a P&L statement (here called an income statement) for the Kraft Heinz Company. Notice that it includes details such as total revenue, operating expenses, and net income from various sources. While a P&L for a small business will likely look very different, this example still offers useful information about how a successful company formats its statement.
What do P&L statements include?
A profit and loss statement should include:
- Total revenue
- Cost of goods sold (COGS)
- Gross profit
- Operating expenses
- Net profit or loss
These are essentially different categories of income and expenses, and when added up will show whether your company is turning a profit or not.
How to make a profit and loss statement
After you pick the time frame you want to analyze, here are the steps to follow to create your own P&L statement.
- Calculate total revenue. The amount will differ depending on whether you use the accrual method or the cash accounting method, so make sure you know which system you’re using.
- Determine the COGS. This includes both the direct and indirect costs of goods sold.
- Subtract COGS from revenue. The resulting amount is your gross profit.
- Calculate expenses. Look at everything your company has to pay to stay in business, including rent, advertising costs, and employee salaries. Subtract this amount from gross profit to determine total operating revenue.
- Determine other income and expenses. If there are taxes, interest, amortization, depreciation, or other revenues and costs not included in the previous calculations, add them in.
- Find the net profit. Subtract the total other income and expenses from operating income to find your net profit or loss.
Try downloading our profit and loss statement template. Use the template instructions in the Excel file to get started.
Types of P&L statements
There are several types of profit and loss statements you can prepare depending on your specific needs and business requirements. Here are some common types:
- Single-step profit and loss statement. This is the most basic and straightforward type of profit and loss statement. It lists revenues and gains on one side and expenses and losses on the other. Subtract the total expenses from the total revenue to calculate the net profit or loss.
- Multi-step profit and loss statement. This type provides more detail by segregating various components of revenue and expenses. It typically includes multiple steps to calculate business profits, operating income, and net income. It allows for a more comprehensive analysis of the company’s financial performance.
- Vertical profit and loss statement. A vertical profit and loss statement presents financial data in a vertical format, with each line item representing a specific category of revenue or expense. It provides a clear breakdown of different income and expense streams, making it easier to analyze and compare figures.
- Horizontal profit and loss statement. A horizontal profit and loss statement presents financial data in a horizontal format, typically comparing figures across multiple periods. This type allows for easy comparison of revenue and expense trends over time, highlighting the changes in financial performance from one period to another.
- Contribution margin income statement. This statement focuses on the contribution margin, which represents the amount of revenue remaining after deducting only the variable costs associated with producing goods or delivering services. It helps in assessing the profitability of individual products or services.
- Pro forma profit and loss statement. A pro forma profit and loss statement is a projected or forecasted statement that estimates future revenues, costs, and expenses. It’s often used for budgeting, business planning, and aiming to predict future business performance.
Single-step vs. multi-step P&L statements
A profit and loss statement can be either single-step or multi-step. To understand what that means, we have to step back a little. Every publicly traded company is required to use Generally Accepted Accounting Principles (GAAP) created by the Financial Accounting Standards Board (FASB), and many private companies choose to comply with GAAP as well. GAAP outlines options for either single-step or multi-step P&L statements.
A single-step P&L is pretty simple: it shows revenue, expenses, and net income. It makes for easier record-keeping, but it may also lack important information that might be useful for your business. This method is more popular with P&L statements than income statements.
A multi-step P&L is more common with larger, publicly traded companies. In addition to tracking revenue, expenses, and net income, it categorizes expenses as either direct costs or indirect costs. This means the document includes a gross profit calculation and an operating income calculation, which can offer a clearer picture of how a business is run. Multi-step processes are more common in income statements than P&L statements.
Other names for P&L statements
This financial statement goes by many names, but they all describe the same thing: a document with a company’s revenue and expenses. The most common terms—”profit and loss statement” and “income statement”—are used interchangeably, but they can mean slightly different things to different kinds of businesses.
Profit and loss statement – Mostly used by small businesses or during internal conversations. Unlike an income statement, these are usually prepared on a cash basis.
Income statement – Medium-sized and enterprise-level businesses mostly use these. This is a commonly used term when reporting financial results to investors, stakeholders, banks, owners, board of directors, and auditors. They’re usually prepared on an accrual accounting basis.
Statement of operations – Mostly used in publicly traded US companies.
Statement of earnings – Not very popular, but occasionally the banking industry will use this term.
Statement of activities – This is only used by charitable organizations classified as 501(c)(3).
P&L statements vs. balance sheets
Both documents are important to your business for different reasons, and they cover different aspects of company finances.
While a profit and loss statement shows income and expenses over a certain period, a balance sheet offers information about a company’s assets, liabilities, and stockholder equity at a specific point in time.
A balance sheet offers greater insight into the liquidity of a company’s finances, while a P&L is more focused on overall financial results.
Why P&L statements matter
Potential investors will want to check out your P&L statements to understand if your company is spending money wisely. And for the sake of transparency, all publicly traded companies are required to release a P&L statement every year.
But even if these factors don’t apply to your organization, a P&L statement provides important insight into the financial health of your business. Business owners should be familiar with their P&Ls so they can make smarter day-to-day decisions and improve future business performance. Knowing where your money is going can help you take your company in the right direction.
Understanding your company’s financial situation
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