How to prepare a profit and loss statement
Small business owners are responsible for all business finances when they first get started. Playing bookkeeper until they can outsource this role, they have to manage all business operations and expenses on behalf of their company. Despite a stream of new analytics and Microsoft tools, a profit & loss (P&L) statement remains the top financial report for tracking business health over time.
From small businesses to enterprise-level companies, businesses of all sizes rely on P&L statements. They can discover financial trends, secure funding, forecast earnings, and predict valuations on the back of one report. And P&L statements are essential for startup founders. Whether it’s a business pitch or a loan application, investors and creditors often request this statement when making decisions.
There are plenty of standalone benefits to preparing a P&L statement. For public companies, however, the main reason is that it’s required by the IRS. In fact, a profit & loss statement is one of three financial statements that public companies must issue quarterly and annually. The other two statements—a cash flow statement and a balance sheet—supplement a P&L statement to identify a business’s performance.
What is a profit and loss statement?
A profit and loss statement is a financial report that summarizes revenues and expenses for a specific period of time. Also known as an income statement or a statement of operations, this report typically covers a time frame of one fiscal quarter or year. A P&L is primarily used to calculate income after revenue and total expenses. That way, business owners can quickly determine whether a business is operating at a profit or loss—and why.
To keep this calculation simple, the formula for a profit and loss statement is:
Revenue - Expenses = Income
If you were to follow this formula exactly, you’d create a simplified version of a P&L statement, known as a single-step profit and loss statement. But most businesses need to prepare a multi-step statement. “Multi-step” refers to how you’ll get better insights by expanding on your profits and costs. This is the preferred method for businesses focused on growth or profitability. If you manage cash with a Brex account, you can generate this report with a few clicks.
It's also important to know how a profit & loss report differs from a cash flow statement and a balance sheet. Cash flow statements detail cash transactions like inflows and outflows over a certain time period. Balance sheets, on the other hand, are a snapshot of a business’s assets, liabilities, and equity at a given moment. Knowing the difference helps you avoid adding the wrong information to each statement.
What to include on a profit and loss statement
The main categories for P&Ls include revenue, cost of goods sold, operating expenses, non-operating expenses, and taxes. Companies use these to calculate performance indicators like gross profit, net operating profit, business profit, gross profit margin, operating income, and total net income. When calculating your P&L, it's common to use some terms interchangeably. For example, income and profits, or expenses and costs. From top to bottom, the following categories are found on most P&L statements:
- Revenue: On the top line, there's revenue, or the income received from the sale of goods or services. These sales can be expressed as total revenue or net revenue, which deducts line items like returns and undeliverable goods. It's common to split this item into revenue streams for easier analysis. For example, sales from pay-per-click ads and sales from email campaigns.
- Cost of Goods Sold (COGS): The direct costs incurred in the production of goods or services. Brick-and-mortar businesses should include material costs, direct labor costs, and factory overhead. An ecommerce business might also include credit card processing fees.
- Gross Profit: The profits left after paying direct costs and before operating expenses. Subtract COGS from revenue to find gross profit.
- Gross Profit Margin: A useful percentage found by dividing revenue by gross profit. This can indicate how well a company is handling direct costs.
Operating Expenses (OPEX): The operational costs of running your business. It's a long list, depending on how you categorize items. OPEX includes business and administrative expenses like payroll, rent and utilities, banking fees, equipment, internet bills, fulfillment, and marketing. Common practice is to sort them into broad categories such as:
- General and Administrative
- Research and Development
- Marketing and Advertising
- Non-Recurring Expenses (Losses to fraud, property damage, lawsuits, etc.)
- Operating Income: This is also called EBITDA (earnings before interest, taxes, depreciation, and amortization). Subtract OPEX from gross profit to get your business's operating income.
- Interest Income: The interest earned from things like investments and bank accounts.
- Interest Expense: The interest incurred from things like loans and purchases on credit.
- Depreciation and Amortization: Factor in depreciation, or the loss of value from tangible assets such as vehicles, and amortization, or the cost of intangible assets like permits.
- Other Income: Add line items here as needed.
- EBT (earnings before taxes): The sum of operating income and other non-operating expenses or income.
- Income Taxes: Report income tax expenses here if you don't report business income on your personal income statement.
- Owner’s Salary: Factor this in as needed.
- Earnings Per Share: The amount your shareholders would receive if you paid out of net income.
- Net Income: On the bottom line, you'll calculate net income, also known as net profit, or your income after all expenses and profit are tallied.
A simple profit & loss statement can give you a good idea of how your company is performing. While you hope to see that your business is operating at a profit, that might not be the case. This is especially true for new businesses. If you do see a profit, remember that P&L statements don't include everything you need to consider—that's where cash flow statements and balance sheets come in.
What isn’t shown on a profit and loss statement?
Profit and loss statements capture a lot of data, but they don't cover all financial aspects of your business. Revenue, for instance, doesn't translate to money received if you allow customers to pay with credit. There are other items not shown on a P&L, which a balance sheet accounts for:
- Assets: Cash on hand, inventory, accounts receivable, etc.
- Liabilities: Loans, wages payable, credit card payments, etc.
- Equity: Owner investments, etc.
A cash flow statement bridges the P&L statement and balance sheet, accounting for operating, investing, and financing activities over time.
Example of a profit and loss statement
We’ll use Apple to explore a real-world profit and loss statement. As a reminder, a P&L statement is also called a statement of operations. It’s helpful for any business owner to see the variety of ways that companies organize their financial data. Instead of providing gross revenue on the top line, Apple lists net sales and cost of sales to calculate gross margin. Next, expenses are categorized into two large buckets: research and development, and selling, general, and administrative. A smaller business may want to use more categories to track spending by area and gain more insight.
On the “bottom line” is net income, where you can see that Apple operated at a profit over the course of three years. When listing losses on these reports, it’s common to put the amounts in parentheses or brackets. This indicates that the number should be subtracted—and also makes it easier to see losses at a glance. Finally, Apple provides information on stock earnings, but not without the help of another financial statement. You’ll use the equity section of your balance sheet to find the number of shares, and then calculate earnings per share. There are many ways to prepare a profit and loss statement, which we’ll cover next.
Preparing a profit and loss statement
If you or your accountant is using business accounting software, the standard reports should include a profit and loss statement. With a Brex account, you can export or print your financial statements in seconds. If you don't use accounting software, we broke down the most popular options in our podcast reviewing accounting software. Alternatively, there are free profit and loss statement templates and software that businesses typically use—like Excel templates and QuickBooks Desktop templates.
We do recommend online software over desktop software because online platforms can integrate with other helpful business tools. Some bank accounts with built-in expense management software can integrate directly with your accounting or bookkeeping software, as well. As many business owners have learned, there's more room for error when financial data is spread among paper, online documents, and desktop tools. By using online accounting software—or hiring a financial analyst who does—you'll also save time on manual input and re-entry.
How do you use a profit and loss statement?
Once you know the terminology, a profit and loss statement is a reasonably straightforward report. A business owner or accountant can prepare and analyze a P&L statement, recommending changes and keeping stakeholders and investors up to speed. If you don't work with an accountant or aren't comfortable managing financial reports, consider outsourcing accounting so you still have access. If you're a new business owner, it might be beneficial to prepare P&L statements on a monthly basis. That way, you can find opportunities and shortcomings earlier, and adjust faster.
If your business is so new that you don't have enough data to create a current P&L statement, there's another option. You can build a pro forma profit and loss statement and make educated guesses by categories, while being conservative with predicted profits and generous with costs. After you’ve been operating awhile, you can track year-over-year growth, too. Here are a few other ways to use a profit and loss statement:
- Determine a profitable yet competitive price for your products
- Forecast future financial health, sales, expenses, and profits/losses
- Be prepared to pitch to investors at any time with consistent, accurate financial reports
A profit and loss statement is a go-to report for understanding a company's ability—and potential—to generate revenue, manage expenses, and become profitable. Together with a cash flow statement and balance sheet, you'll get a complete picture of your business's financial standing, and make better long-term decisions.