Guide to Understanding Profit & Loss Statement (P & L)
Updated: Aug 6, 2021
As a business owner, understanding your company’s overall financial health is a crucial part of growth and success. The three important financial statements used for reporting a company’s financial performance are the Balance Sheet, the Profit and Loss Statement (P&L) and the Statement of Cash Flows.
The Balance Sheet reports a company’s assets, liabilities and shareholders' equity at a specific point in time. It provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders.
The Statement of Cash Flows is the net amount of cash and cash equivalents being transferred into and out of the company. Cash received represents inflows, while money spent represents outflows.
The P&L Statement or Income Statement, which we will learn more about, provides a summary of a company’s revenues, expenses, and profits/losses over a given period. The P&L Statement shows a company’s ability to generate sales, manage expenses, and create profits.
A P&L Statement allows you as a business owner to review how well your company performed over a chosen period. With the results in mind, you will then be able to make better financial decisions, as you are armed with concrete knowledge of how your business is doing in terms of revenue and expenses. You would also be able to show a chronological record of how well your business has been doing over the course of its operation, allowing you to play your cards right around investors and creditors, or with buyers if you have the intention of selling the business. It also serves as a measure of trust, as it may be requested by any new clients who wish to do business with you.
The main categories that can be found on the Income Statement include:
Revenue (or Sales) – includes sales and money you receive from things like selling property and equipment or receiving tax refunds.
Cost of Goods Sold (or Cost of Sales) - expenses imposed both directly and indirectly to produce goods or services in the conditions and places where the goods can be sold or used.
Selling, General & Administrative (SG&A) Expenses – includes all costs associated with running your company that are not included in the COGS, such as payroll, travel, training, leases, utilities, equipment purchases, hardware and software, advertising, cell phones, and internet services.
Interest Expense – the cost of borrowing money during a specified period of time.
Depreciation – the process of allocating the cost of a tangible asset over its useful life and is used to account for declines in value.
Net Income (loss) – the overall profitability of a company after all expenses and costs have been deducted from total revenue.
To prepare a P&L Statement, you first add up all sales made during the period. You then list the expenses and determine whether they should be included in cost of goods sold or selling, general & administrative. The next steps are to calculate interest expense and depreciation. Then, deduct all expenses (cost of goods sold, selling, general & administrative, interest and depreciation) from total sales to arrive at earnings before taxes (EBT). Then, calculate taxes and subtract taxes from EBT to find out whether your company made a profit or loss for the period.
One important thing to know before you prepare your P&L is whether you are on a cash basis or accrual basis of accounting. With a cash basis, revenue and expenses are recognized when there’s movement of cash (for example, if you agree to pay a vendor $50 for a service in a month, you don’t account for that until the $50 leaves your bank). The accrual method accounts for revenue when it is earned (before the money reaches the bank) and expenses when they are incurred (but before the vendors have been paid).
If you’re unsure how to prepare your P&L Statement, CPA by Choice can help. We are available to answer your questions, feel free to call us or send us a message.