If you haven’t heard the term P&L before, don’t confuse it with PB&J or you’ll find yourself in a jam. Hey, if you have, we won’t judge—as long as you don’t judge our puns.
But to be clear, we’re talking about profit and loss statements (also called income statements).
A profit and loss statement is a financial document that provides an overview of your business’s total income and total expenses in a set period of time.
Before we (figuratively) dive into the ooey-gooey goodness of P&Ls, here’s a quick snapshot of what you need to know:
- P&L statements are prepared using cash basis accounting or accrual basis accounting
- There are three financial statements that public companies are required to issue quarterly and annually: the P&L statement, the balance sheet, and the cash flow statement
- When combined, the P&L report, balance sheet, and cash flow statement act as a triple threat, providing a comprehensive look at your business’s financial performance
- Keep an eye on things, especially those P&L statements from different accounting periods so you can note any changes or trends, not just the numbers
How do profit and loss (P&L) statements work?
A profit and loss statement is all about financial health. It shows a company’s gains and expenses over a set period of time.
But it doesn't work alone.
A profit and loss statement is part of a trifecta of financial statements that every public—but not private—company is required to issue on a quarterly and annual basis. These include the following: balance sheet, cash flow statement, and the P&L report.
The latter of this list (and the focus of this article) is typically the most popular of the three in business plans. That’s because profit and loss statements give an in-depth look at the revenue, costs, and expenses incurred in a specific period of time, like a quarter or a year.
Example: Profit and loss statement
More a visual learner? Us, too. That’s why we’ve put together this example of a profit and loss statement, shown here. 👀
The key components of profit and loss statements
This is the first part of your profit and loss statement. It’s a standard part of a P&L statement, and includes the name of your business and the accounting period that the statement covers.
This type of entry brings in your net sales (i.e. what’s leftover after deductions—like returns, allowances and discounts—that have been subtracted from gross sales) or receipts during the accounting period. It includes the revenue earned from the primary operating activity of your business, plus non-operating revenue.
Cost of goods sold
These are the direct expenses your business has incurred in order to produce products or deliver business services to your customers. Also known as COGS, it includes costs related to direct labor and materials costs, shipping and delivery fees, or things like production costs.
Gross profit is the profit your business makes after you’ve deducted all the costs associated with making your products or offering your services. Essentially, it’s the net revenue minus the cost of the goods sold. This is also known as gross income or gross margin.
These are your administrative, general, and selling expenses. Operating expenses can include things like rent, payroll, utilities, business supplies, and any other indirect costs that are needed to stay up and running. These are commonly referred to as non-cash expenses.
Other income and expenses
Sometimes, businesses choose to break out their revenues and expenses into a separate section of their statement. This could include things like gains and losses or other revenues that aren’t frequent.
Net income (also known as net profit) is the total amount earned after deducting all of your expenses. To calculate it, subtract the total expenses from the gross profit of your business.
How to prepare a profit and loss (P&L) statement
Ready to prepare your P&L statement? You can do this in two ways: the single-step method or the multi-step method.
But before you rush off to find your calculator, grab the essentials first: invoices, receipts, bank transactions, and any other financial documents that you’ll need to answer the components listed above.
The single-step method
Are you a small business or operating in a service-based industry? Then this might be your method of choice. It calculates net income by subtracting expenses and losses from revenues and gains.
It gets its name from the fact that it uses a single subtotal for all revenue line items and a single subtotal for expense items. You can find your net gain or loss at the bottom of the statement, which is known as the “bottom line” in accounting.
The multiple-step method
If you’re operating as a larger business and want a more in-depth look into your profits and financial operations, you’ll be more inclined to use the multi-step method, which—if you haven’t guessed—has a few more steps than the single-step method.
Three, to be exact. You’ll first calculate gross profit, then calculate operating expenses, and then calculate net income (aka net profit).
Are profit and loss statements important for small businesses?
Short answer: yes. Profit and loss statements are important, and they’re also sometimes required. For example, if you’re a publicly traded company, you’ll need to issue one. Or, if you’re a small business who requires a loan, your bank might want to see one. You also might need one during tax time.
But let’s get back to why they’re so valuable. P&Ls offer some major insights, like the ones listed below.
Where profit is coming from
Selling multiple products? Offering various services? A P&L lets you break them down into separate line items on your statement. This is key to helping you determine which line items are most profitable, and which ones aren’t.
Whether costs are being managed well
Your P&L report lets you take a trip down memory lane, but unlike those other reminiscent times, this trip’s much more objective. For instance, you can take a look at past quarters or years and their profit and loss statements for a comparative analysis. This helps you determine things like if expenses are growing faster or slower than expected, or if they’re on par with what your business needs.
For instance, if your revenue increased by 10% from the prior year, but your material costs jumped by 40%, you’ll want to understand the why’s and how’s behind the numbers.
If business operations are profitable
Consider this perk the pièce de résistance of profit and loss statements: your bottom line showing you if you’re turning a profit or not. And remember: this is actually at the bottom of your statement. 💡
Profit and loss statement FAQs
What is the difference between a P&L statement and a balance sheet?
Although balance sheets and P&L statements each have a lot of the same information, there are some key differences between the two.
For instance, a balance sheet reports assets, liabilities, and shareholder equity for a certain point of time. But a profit and loss statement provides an overview of your business revenues, costs, and expenses, typically quarterly or annually.
Plus, if you’re a publicly traded company, a P&L statement will also give you information like earnings per share. This shows how much money your shareholders would get if your company were to distribute all of its net earnings for that specific period.
Do all companies need to prepare P&L statements?
No, it’s not mandatory for private companies to prepare P&L statements, but publicly traded companies are required to do so.
That said, even small and private businesses still file them. They can be incredibly valuable, helping you monitor your financial health.
What is the difference between a P&L statement and a cash flow statement?
A cash flow statement is part of the three financial documents that businesses pull together every year—sometimes annually, sometimes quarterly. The cash flow statement shows the exact amount of a business’s cash inflow and outflow over a specific period of time. A P&L statement is different in that it provides an overview of your company’s total income and total expenses over that period of time.
Moving ahead with profit and loss statements
Profit and loss statements go by a lot of names: income statements or a statement of operations. They’re prepared using the cash basis accounting method or the accrual basis accounting method, and are a critical part of understanding the financial state of your business—past, present, and future.
When you combine an P&L statement with other documents like cash flow statements and balance sheets, you get a detailed look at the quarter or year, including the revenue, costs, and expenses your business has incurred. Mix that in with profit and loss statements from quarters past, and you’ve got a data-driven crystal ball of information: trends and changes, and numbers that give you an objective look at what’s to come.
And remember: P&L statements aren’t always required (unless you’re a publicly traded company), but they are useful. Who doesn’t want a plethora of practical knowledge right at their fingertips? We certainly do—and because you’re here, we’re assuming you’re in the same boat.
So, if after reading this article you find yourself yelling “Show me the money!”, you’re in luck. For one, Jerry Maguire is streaming on Netflix, and secondly, Wave can help.
We make accounting easy, helping you with the trifecta of financial documents: cash flow statements, balance sheets, and—you guessed it—P&L statements, too. Because when it comes to making better business, three’s never a crowd.
P.S. Looking for the Oscar-worthy version of P&L statements? Take a look at our video to learn more about preparing your income statement, and what you can find when you do. 🔮
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