What Is a Profit and Loss Statement

When it comes to business finances, the understanding of all its aspects is key to success. An imperative part of your finances is understanding what a profit and loss statement is. Profit and loss statements are used for several things and are indicators of the health of a business. They can be used to review your business over time, or even on a day-to-day basis, and can influence business decisions factually.

Using our article, learn everything you need to know about profit and loss statements and help you understand your business’s finances more intimately.

Profit and Loss Statements

Profit and loss statements, also known as P&L statements, are a statement that is released quarterly and annually by all businesses. The statements they are released alongside are the balance sheet and the cash flow statement. Profit and loss statements are a set of documents that summarizes revenues, costs, and expenses incurred during the period that they are released for, be it a quarter or a fiscal year. You can even drill them down to make them more granular and look at things daily if your reporting allows for it.

When analyzed correctly, profit and loss statements can be used to determine change over periods related to revenue, operating costs, spending, and net earnings. These numbers, when analyzed together, are more important than the numbers themselves. They’re an in-depth look at performance over time, especially when used in conjunction with the balance sheet and cash flow statements.

Profit and loss statements are also known as income statements and show a company’s ability, or inability, to generate profit. This can be shown by looking at the numbers that involve increasing revenue or reducing costs, or both. These figures are what drives good business decisions and ultimately influence a business’s path over time.

Understanding the Numbers

Profit and loss statements are the most important financial statements in a business plan. It shows how much profit is generated by a business and shows the losses that the business incurred. These statements are used to show changes over a set period, whereas the balance sheet is a snapshot of a business at a given moment in time. Balance statements show what a business owns and what it owes at a given time, while profit and loss statements show how much it’s made or lost over time.

For the most part, profit and loss statements are made up of the same facts and figures. The sections are as follows:

Income or Revenue

Simply put, income, or revenue, is the money made by a business over a set period. Generally, as with the other sections in the profit and loss statement, it is subsidized. This allows you to see where the income you’ve generated for the period you’re analyzing has come from.

Cost of Goods Sold

Cost of goods, or COGS, relates specifically to the costs incurred for the products you’ve sold. This part of the statement can also be subsidized and can show you what you’re paying for your materials. It’s a good way of determining if what you’re selling your goods for is an appropriate amount and that you’re making a profit off of them.

Expenses

The expenses section is meant for any expenses your business has incurred over the period that you’re analyzing. These expenses are unrelated to the cost of the goods you’ve sold, like advertising, marketing, and peripherals like websites.

Other Income and Expenses

This section is more related to financial income or expenses. An example of other income would be interest generated over time, income from investments, or one-time income from a source that you don’t usually receive income from (think gifts). Other expenses could be taxes and penalties, reimbursable expenses, and one-time extraordinary expenses like legal fees.

Net Income

Net income is the final calculation of your profits and losses statement. By analyzing your revenue generated through income and other income and then subtracting your costs and expenses, you can determine your net income for the period you’re reviewing.

How to Use Your Profit and Loss Statement

We’ve talked about the usefulness of profit and loss statements in being used to determine the viability of your business, and the health of your business, but how exactly do you do that? Generally speaking, there are three different ways to use profit and loss statements as a business. Those are illustrations of viability in a business plan, internal analysis, and tax preparation.

Business Plans

When using profit and loss statements in conjunction with a business plan can be exceptionally useful. It’s a powerful tool when comparing statements from different periods to show profitability in your business. If pursuing a business loan, or any form of funding, then by using a profit and loss statement that displays high income and low costs, you’re able to illustrate that your business is worthwhile for investment. Positive profit and loss statements help you obtain loans and outside sources of funding when necessary.

Internal Analysis

Using your profit and loss statements, you can execute an internal analysis of your business and drill down where you’re making your money and where you’re losing it. By looking at the itemized portions of your profit and loss statements, you can determine which products are making you money and which ones are costing you more than they’re worth. These statements are a fantastic way of watching the life of a business and allow you to predict where revenue will come from and where costs will begin to become too high.

Tax Preparation

Use detailed profit and loss statements when preparing the taxes for your business, as these documents show an entire fiscal year’s worth of data. They’re used to track and itemize income and expenses and allows for accurate tax preparation so that you can be sure to have an accurate tax return.

Using Profit and Loss Statements Over Time

Using these statements can help to plan your business strategy. In addition to the three uses above, when looking at profit and loss statements over time, you can see things like:

  • Business growth throughout a business’s life
  • Both positive and negative impacts that are affecting your revenue
  • Costs that are inhibiting higher profit yields
  • Patterns over time that are related to sales trends

These longer periods allow for you to handle growth and losses organically, and can allow you to predict where you’ll see higher income based on existing trends.

Using Profit and Loss Statements to Look at the Day-to-Day

While profit and loss statements are often used to look at the big picture, they can also be prepared in such a way that allows you to review your day-to-day operations. Day-to-day operations that can be observed are things such as:

  • How you make the majority of your money
  • Where your business may be losing money
  • Where your cash flows to, based on spending

In businesses like restaurants, observing these day-to-day trends can help in operations like the preparation of food, supplies, and manpower.

Questions That Profit and Loss Statements Can Answer

By reviewing your profit and loss statements, you can answer several questions about your business. By reviewing your income, you can determine if you’re charging the correct amount for a product by calculating its profitability. 

Additionally, you can cut costs by removing goods and services that don’t meet your standards for profit. This ability to predict your revenue and costs by reviewing trends can help to drive profits higher by removing dead weight and adjusting prices to suit the needs of your customer base.

The Takeaway

Profit and loss statements are invaluable financial reports for any business. Tracking income and costs over time can strengthen your business strategies and lead to stronger decision-making processes. Profit and loss reports illustrate over different periods how profitable your business has been or how much improvement needs to be made to become as profitable as you’d like to be.

In addition to understanding your business as it grows and changes over time, profit and loss statements can help you adjust your day-to-day operations. Looking at how goods and services are performed on different days can allow you to alter your business model and short-term business strategies. You can do this by looking at the associated revenue and spending daily. Understanding profit and loss statements are a great way to understand your business truly.

 

Sources:

How Does a Business Use a Profit and Loss Statement? | thebalancesmb.com

Profit and Loss Statement (P&L) Definition | Investopedia

Q: What Is a Profit and Loss Statement? [Free Template] | gusto.com

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