A profit and loss (P&L) statement, also known as an income statement or statement of earnings, is a vital financial document that provides insights into a company’s financial performance during a specific period. It offers a comprehensive overview of a company’s revenues, costs, and expenses, enabling stakeholders to evaluate its profitability.
Analyzing P&L statements enables investors, managers, and business owners to make informed decisions about product development and management and continuously identify areas for improvement.
What is a profit and loss (P&L) statement?
A profit and loss (P&L) statement is a type of financial statement covering a specific period and revealing a company’s revenues, costs, and expenses. Ultimately, it helps show whether a company is making a profit or losing money.
How profit and loss statements work
Profit and loss statements are crucial to prove to potential investors that your company is fiscally responsible and profitable.
Many components make up a P&L statement, but they all fall into one of three categories:
- Revenue
- Expenses
- Net income
Revenue
Revenue will summarize how much money was made by the company within the specified period. It simply keeps track of revenue or sales. Some ways to calculate revenue include:
- Total number of units sold * average price
- Total number of customers * average price per unit
Revenue can also include net revenue which is the gross revenue minus adjustments. This can involve refunds, returns, discounts, or commissions.
Expenses
Expenses summarize how much your company spent within the specified period. It involves any costs involved with running your business. Some examples include:
- Rent
- Utility bills
- Employee compensation
- Insurance
- Marketing campaigns
Net income
Net income is essentially your company’s bottom line. You take the revenue you earned and then subtract your expenses. The result is your company’s profitability.
While this isn’t the only financial data to indicate the success of your business, it can help you determine what is and isn’t working financially.
P&L statement vs. balance sheet
Keep in mind, a profit and loss statement is different from a balance sheet, although they are both crucial financial documents for companies. P&L statements focus on income and expenses. Meanwhile, a balance sheet shows a bigger and more detailed picture of a company’s financial position since it also includes assets, liabilities, and stockholder equity.
What are the 5 components of a profit and loss statement?
Now that you have the general overview of a profit and loss statement, let’s dive into more detail about what it includes.
The five components of a P&L statement are:
- Revenue — Net sales fall into this category, and any other income the company earned during the period
- Cost of goods sold (COGS) — Direct expenses involved in delivering a product or service to the customers. Examples include the cost of raw materials and direct labor costs
- Operating expenses — Expenses related to running the business, such as administrative, general, and selling expenses. Examples include payroll and advertising
- Gross profit — Calculated by subtracting COGS from the net revenue
- Net profit — Calculated by subtracting total expenses from the net profit. The result shows the total amount earned after accounting for all expenses and revenue
What are the two types of profit and loss?
There are two types of accounting principles to create the profit and loss statement: the cash accounting method and the accrual method. Depending on which meth you choose, your P&L statement may look very different.
Here is a breakdown of each profit and loss accounting principle:
- Cash accounting method — Transactions are recorded when money is actually exchanged. Revenue is accounted for on the day it’s received, and expenses are recorded when they are paid
- Accrual method — Transactions are recorded when it occurs and not when money is received or sent. For example, you send an invoice but a client doesn’t pay until 23 days later. You record the revenue on the day you send the invoice
How do you calculate a profit and loss statement?
The best approach to profit and loss calculate will vary depending on whether your company uses the single-step or multistep approach.
Single-step P&L calculation
The single-step profit and loss statement is fairly straightforward: you take the total revenue and subtract the total expenses. The result is your company’s net income.
P&L = Total expenses – Total revenue
If revenue is higher than your expenses, your company has a net profit. But if your expenses are more than your revenue, then your company has a net loss.
The single-step method makes record keeping easy, but it could also cause you to miss valuable information on your business performance. Single-step P&L statements are more commonly used by service providers and small businesses.
Multistep P&L calculation
The multistep profit and loss statement is more detailed than the single-step approach. While it also tracks income, expenses, and net income, it breaks down expenses as direct costs or indirect costs.
This means you can use those numbers to calculate your company’s gross profit and net operating income, which tends to pain a more accurate picture of what is happening with your business.
Multistep P&L statements are frequently used by large businesses to better understand what’s driving their profitability.
The multistep method involves three components:
- Revenue — Subtract the cost of goods sold (COGS) from the revenue to calculate the gross profit
- Gross profit — Subtract the operating expenses from the gross profit to calculate the operating income
- Operating income — Add any other income and subtract any other expenses to calculate the net profit
Example of a P&L statement
P&L statements will look different depending on the company size, accounting method, and whether they choose the single-step or multistep approach.
For example, here’s a profit and loss statement from Meta Platforms, Inc.:
Smaller organizations may have simpler P&L statements. Here’s an example of a P&L statement from a small business:
How to analyze P&L statements
A profit and loss statement is valuable for financial analysis because it proves the profitability of a company, which can make it more attractive to prospective investors. Put simply, a P&L statement can prove the financial strength of a company.
Investors can use a P&L statement to:
- Evaluate a company’s performance over time by using horizontal analysis and margin analysis
- Discover rates of return, such as return on equity (ROE) and return on assets (ROA)
- Determine whether trends are increasing or decreasing
A P&L statement is also important to internal operations. It can show fluctuations and flaws in income and expenses and what needs to be done to improve the financial position of the company. This may involve finding additional sources of revenue or reducing expenses.
Here are a few findings a company might discover by analyzing its P&L statement:
- What products or services drive more profits compared to other offerings
- What products or services are increasing expenses without producing as much revenue
- What expenses are increasing faster than anticipated
- Whether the company is profitable
Profit and loss statement template
A profit and loss statement (P&L), also known as an income statement or statement of earnings, is a crucial financial document that provides insights into a company’s financial performance. It summarizes revenues, costs, and expenses, allowing stakeholders to evaluate profitability.
To help you track and analyze your company’s financial health, we have prepared a profit and loss statement template:
| Amount | |
|---|---|
| Revenue | [Enter revenue amount] |
| Cost of goods sold (COGS) | [Enter COGS amount] |
| Operating expenses | [Enter operating expenses amount] |
| Gross profit | = Revenue – COGS |
| Other income | [Enter other income amount] |
| Other expenses | [Enter other expenses amount] |
| Net operating income | = Gross profit + (Other income – Other expenses) |
| Interest expense | [Enter interest expense amount] |
| Taxes | [Enter taxes amount] |
| Net profit | = Net operating income – Interest expense – Taxes |
We’ve also created a customizable, plug-and-play version of this profit and loss statement template in Google Sheets. Simply enter your financial data, and the table will automatically calculate key figures such as gross profit, net operating income, and net profit.
Note: To use the template, first make a copy by selecting File > Make a copy from the menu above the spreadsheet.
Key takeaways
A profit and loss (P&L) statement is one of the most important financial documents for a company. It can clearly show whether a company is making a profit or not. It can also break down income and expenses for further analysis and reveal areas needing improvements.
The P&L statement is a snapshot of the company’s financial state. Regularly creating and analyzing the changes in the profit and loss statement over time can help you better understand how your company’s products and services are performing.
It’s crucial to create accurate P&L statements so you can know whether your expenses are worth their cost. Otherwise, you risk not knowing what is causing the failure or success of your business.
Featured image source: IconScout
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