Profit and loss statement: Your business's financial report card

Would you rather base your business decisions on assumptions, pulling numbers out of thin air? Or would you prefer a clear, concise understanding of your revenue, expenses, and profitability? A profit and loss (P&L) statement provides this clarity.

A P&L statement is a great tool to have a solid understanding of your business's financial health. It's not just for accountants and Wall Street types; it's for anyone who wants to understand where their money is going, and how to make it work harder for them.

This guide will walk you through the definition of the profit and loss statement and all the details, from understanding its key components to analyzing your results.

What is a profit and loss statement?

The profit and loss statement, also known as an income statement, is a financial tool that shows you a snapshot of your business's financial performance over a specific period (usually a month, quarter, or year). It breaks down your revenue and expenses, revealing whether you're in the black or the red.

Now, before you start picturing complicated spreadsheets with more numbers than a phone book, let's simplify things. 

How do profit and loss statements work?

The P&L statement follows a simple structure, starting with your revenue and then subtracting the costs of running your business. These costs include everything from making your products or services to the expenses of keeping the lights on. The difference between your revenue and expenses is your net income (or profit/loss).

Here’s the straightforward formula:

Revenue - Expenses = Profit (or Loss)

While this is a basic formula, the statement itself presents a more detailed breakdown to provide a clearer understanding of the company's financial performance. 

Below, you’ll find a step-by-step explanation of the typical flow followed by an example of a profit and loss statement. Consider it also as your guide on how to do a profit and loss statement.

1. Revenue

The money your business generates from selling goods or services. It's the first component of a P&L statement.

• Gross revenue: The total amount earned before accounting for any deductions. It's also referred to as total revenue, total sales, or gross sales
• Discounts and returns: This section accounts for price reductions offered to customers (discounts) and the value of goods returned
• Net revenue: The revenue remaining after deducting discounts and returns, representing the actual revenue earned from sales. It's also known as net sales
• Gross Revenue - Discounts and returns = Net revenue

For instance, imagine you sold $150,000 worth of products in one month (gross revenue). But you offered discounts totaling $4,000 and had $1,000 worth of returns.

• Your net revenue = $150,000 - $4,000 - $1,000 = $145,000

2. Cost of goods sold (COGS)

Cost of goods sold (COGS) represents the direct costs associated with producing the goods or services sold. It includes:

• Raw materials
• Direct labor costs
• Manufacturing overhead (e.g., utilities for the factory)

Following our example, to generate that $145,000 in net revenue, you incurred the following costs:

• Raw materials: $40,000
• Direct labor: $20,000
• Manufacturing overhead: $5,000
• COGS = $40,000 + $20,000 + $5,000 = $65,000

3. Gross profit

Gross profit is the money your business makes from sales after subtracting the COGS. This figure reflects the profitability of the core business operations before considering other expenses.

• Gross profit = Net revenue - Cost of goods sold

Example (continued):

• Your gross Profit = $145,000 (Net Revenue) - $65,000 (COGS) = $80,000

4. Operating expenses

Operating expenses are the costs of running your business, including managing your working capital. These expenses may include:

• Salaries and wages (for employees not directly involved in production)
• Rent and utilities for office space
• Marketing and advertising expenses
• Research and development costs

In our profit and loss statement example, your operating expenses for the period were:

• Rent and utilities: $10,000
• Salaries (sales staff, administrative): $15,000
• Marketing: $5,000
• Your total operating expenses = $10,000 + $15,000 + $5,000 = $30,000

5. Operating income

With those numbers in hand, we can calculate your operating income. It provides a clear picture of how effectively a company generates money from its primary business activities.

• Operating Income = Gross Profit - Operating Expenses

Example (continued):

• Your operating income = $80,000 (gross profit) - $30,000 (operating expenses) = $50,000

6. Non-operating expenses

Non-operating expenses are costs not related to a company's core business operations. These typically include:

• Interest expenses on loans
• Losses from investments or asset sales
• Taxes
• Fines or legal fees

Let’s say you had the following non-operating expenses:

• Interest expense on a loan: $2,000
• Taxes: $8,000
• Your total non-operating expenses = $2,000 + $8,000 = $10,000

8. Net income (profit or loss)

Finally, this is the final calculation of the profit and loss statement. It reflects the money left over after subtracting all expenses (both operating and non-operating) from revenue.

Net Income = Revenue - COGS - Operating Expenses - Non-Operating Expenses

Finally, your profit and loss statement example looks like this:

Your net income = $145,000 (Revenue) - $65,000 (COGS) - $30,000 (Operating Expenses) - $10,000 (Non-operating Expenses) = $40,000

Your business had a net income of $40,000 for the period.

Are you having trouble with your cashflow? Learn how you can master your cashflow with invoice financing.

Accrual accounting vs. cash basis accounting

When it comes to creating your profit and loss statement, you have two main accounting methods to choose from: accrual accounting and cash basis accounting. Think of them as two different ways of tracking your financial flows.

Cash basis accounting

With this method, you record revenue when cash hits your bank account and expenses when you pay them. It's easy to understand and perfect for small businesses just starting.

Cash basis accounting example: Imagine your logistics company delivers a shipment for $2,000. With cash basis accounting, you record the $2,000 in revenue when the client pays their invoice and the money reaches your account.

Accrual accounting

Accrual accounting records revenue when it's earned, regardless of when the cash is received. The same goes for expenses when they're incurred, also regardless of when they're paid. It gives you a more accurate picture of your business's financial health, especially if you offer credit to customers or have a lot of ongoing expenses.

Accrual accounting example: Your logistics company completes a complex delivery for a client and invoices them for $10,000. With accrual accounting, you record the $10,000 in revenue when the invoice is sent, even if the client has a 30-day payment term and hasn't paid you yet.

The best accounting method for a particular business depends on its specific needs and circumstances.

• Small businesses with straightforward transactions and a focus on cashflow management might find the cash basis method more suitable
• Larger businesses, businesses with inventory, or those required to adhere to GAAP rules should use the accrual method

Types of profit and loss statements

While the fundamental structure of a profit and loss statement remains consistent, businesses can use different formats and variations depending on their specific needs and reporting requirements.

1. Single-step profit and loss statement

A single-step P&L statement takes a simplified approach to presenting financial information. It groups all revenue streams into a single category and does the same for all expenses, regardless of their nature.

Net income is then calculated with a single subtraction of total expenses from total revenues. This format is easy to prepare and understand but may not provide as much detailed information as others.

2. Multi-step profit and loss statement

Like the example we’ve covered, a multi-step P&L statement provides a more granular view of a company's financial performance. It separates operating revenues and expenses – those directly related to the core business activities – from non-operating items.

By calculating gross profit, operating income, and net income in separate steps, this format offers a clearer understanding of how different aspects of the business contribute to the overall profitability. The level of detail can be valuable for larger companies, external stakeholders like investors, and in-depth financial analysis.

Read more: 5 tips for securing the capital you need to scale your business.

3. Comparative profit and loss statement

As the name suggests, comparative P&L statements present financial data for two or more periods side-by-side.

Business owners and analysts can quickly identify trends, assess growth patterns, and pinpoint the impact of changes in business operations, market conditions, or strategic decisions.

4. Common-size profit and loss statement

Common-size P&L statements provide a standardized view of financial performance by expressing each line item as a percentage of revenue. 

Instead of presenting absolute figures, every line item in a common-size statement is expressed as a percentage of revenue. This approach highlights the relative proportions of various expenses to revenue, offering insights into a company's cost structure, efficiency, and profitability compared to its peers.

5. Variance profit and loss statement

Variance P&L statements focus on deviations from expectations. They compare actual financial results to budgeted or forecasted figures, helping to identify areas where actual performance differed from the plan. 

6. Composite profit and loss statement

For larger organizations with multiple business units, subsidiaries, or departments, composite P&L statements offer a consolidated view of overall financial performance. These statements aggregate the financial data from individual entities into a single, comprehensive report.

How to use your profit and loss statement?

You've created your P&L statement, but now what? It's time to analyze your results. This is where you uncover insights that can help you grow your business.

By assessing your statement, you can identify which activities are generating a return on investment and which are draining your resources. You’ll be able to make strategic moves within your business, keep your focus on the right activities, and ultimately make money.

Essentially, a profit and loss statement allows you to:

• Track financial performance: It gives you a view of your revenue, expenses, and profitability
• Identify trends and patterns: Over time, it allows you to spot trends, patterns, challenges, and opportunities that might be hiding in plain sight
• Make informed decisions: It provides the data you need to make smart decisions about pricing, expenses, and resource allocation
• Facilitate funding: When you need to secure funding for your small business, a well-presented P&L statement is your ticket to the big leagues. It shows that your business is a solid investment
• Tax reporting: It’s an essential document for tax reporting and compliance. It provides a clear record of your income and expenses, which you'll need to file your taxes

Don't just look at your numbers in isolation, though. Compare your P&L statement to previous periods, industry averages, and your competitors. Here are some questions to ask yourself when analyzing your statement:

• Are your sales increasing or decreasing? If your sales are decreasing, what factors might be contributing to this trend?
• Are your expenses rising or falling? If your expenses are rising, what steps can you take to control costs?
• Are your profit margins healthy? How do your profit margins compare to industry averages and your competitors?
• What areas of your business are most profitable? Where should you focus your efforts to maximize your returns?
• What areas of your business are least profitable? Should you consider cutting back on these areas or finding ways to improve their profitability?

Learn more: Financial performance metrics – Definition and examples.

Why are profit and loss statements important?

Profit and loss statements are more than just a bunch of numbers on a page. They're your business's financial report card, showing exactly where your money is going. This information is crucial for making informed decisions about your business, from pricing strategies to expense management.

But here's the thing: P&L statements aren't just for you. They're the key to unlocking funding from lenders and investors. A strong statement tells them you're a solid bet, a business worth investing in.

And once you've got your P&L statement looking sharp, then you’ll need the right partner to help you turn those numbers into real growth. But traditional finance is a long, winding road. You're building a business that's built for speed – and you need a partner that moves at the pace of your industry.

Enter Stenn. We’re here to help you ditch the slow lane and hit the fast track. We offer flexible, fast financing alternatives like revenue-based financing and invoice financing, built for e-commerce, SaaS, and international trade.

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Profit and loss statement: Frequently Asked Questions (FAQ)

Profit and loss statement vs. income statement: What’s the difference?

There’s no difference. Profit and loss statements and income statements are synonymous terms. They both refer to the same financial document that shows a company's revenue, expenses, and ultimately, its profit or loss over a specific period.

Are all companies required to prepare profit and loss statements?

While publicly traded companies are legally mandated to prepare P&L statements and make them accessible to investors and regulators, private companies are not subject to the same requirement. 

However, preparing P&L statements is highly recommended for all businesses, regardless of size, as they serve as valuable tools for financial management and decision-making. Smaller companies might not create formal financial reports, but even a basic P&L can be beneficial for tracking their financial performance.

What is the difference between a P&L statement, a balance sheet, and a cashflow statement?

The P&L statement shows a company's financial performance over time, detailing revenue, expenses, and profit or loss. The balance sheet provides a snapshot of a company's financial position at a specific moment, outlining assets, liabilities, and equity. Finally, the cashflow statement tracks the movement of cash into and out of the company over a period, showing how the company generates and uses cash.