How to prepare a profit and loss statement
Despite the stream of new analytics tools, a profit and loss (P&L) statement remains the top financial report for tracking business health over time and making swift improvements.
From small businesses to enterprise-level companies, businesses of all sizes rely on P&L statements. They can discover financial trends, secure funding, forecast earnings, and predict valuations on the back of one report. Furthermore, P&L statements are essential for startup founders. Whether it’s a business pitch or a loan application, investors and creditors often request this statement to make a decision.
There are plenty of standalone benefits to preparing a P&L statement. For public companies, however, the main reason is that it’s required by the IRS.
In fact, a profit and loss statement is one of three financial statements that public companies must issue quarterly and annually. The other two statements—a cash flow statement and a balance sheet—combine with a P&L statement to clarify how a business is truly performing.
What is a profit and loss statement?
A profit and loss statement, also known as an income statement or a statement of operations, is a financial report that summarizes revenues and expenses for a specific period of time. The report typically covers a fiscal quarter or year.
The report is primarily used to calculate income after revenue and expenses. That way, business owners can quickly determine whether a business is operating at a profit or loss—and why.
For that reason, the most basic math formula for a profit and loss statement can be expressed as:
Revenue - Expenses = Income
If you were to follow this formula exactly, you’d create a simplified version of a P&L statement, known as a single-step profit and loss statement.
But most businesses need to prepare a multi-step statement. “Multi-step” refers to how you’ll enable better insights by expanding on your profits and costs. This is the preferred method for businesses focused on growth or profitability. If you manage cash with a Brex account, you can generate this report with a few clicks.
It's also important to know how a profit and loss statement differs from a cash flow statement and a balance sheet.
Cash flow statements detail cash inflows and outflows over a certain time period. Balance sheets, on the other hand, are a snapshot of a business’s assets, liabilities, and equity at a given moment. Knowing the difference helps you avoid adding the wrong information to each statement.
What to include on a profit and loss statement
The main categories for P&Ls include revenue, cost of goods sold, operating expenses, non-operating expenses, and taxes. Companies use these to calculate performance indicators like gross profit, gross profit margin, operating income, and total net income.
From top to bottom, the following categories are found on most P&L statements. It's common to use some terms interchangeably, like income and profits, or expenses and costs.
- Revenue: On the top line, there's revenue, or the income received from the sale of goods or services. These sales can be expressed as total revenue or net revenue, which deducts items like returns and undeliverable goods. It's common to split this item into revenue streams for easier analysis. For instance: sales from pay-per-click ads and sales from email campaigns.
- Cost of Goods Sold (COGS): The direct costs incurred in the production of goods or services. Brick-and-mortar businesses should include material costs, direct labor costs, and factory overhead. An ecommerce business might also include credit card processing fees.
- Gross Profit: The profits left after paying direct costs and before operating expenses. You subtract COGS from revenue to find gross profit.
- Gross Profit Margin: A useful percentage found by dividing revenue by gross profit. This can indicate how well a company is handling direct costs.
- Operating Expenses (OPEX): The operational costs of running your business. It's a long list, depending on how you categorize items. OPEX includes business expenses like payroll, rent and utilities, banking fees, equipment, internet bills, fulfillment, marketing, and so on. Common practice is to sort them into broad categories such as:
- General and Administrative
- Research and Development
- Marketing and Advertising
- Non-Recurring Expenses (Losses to fraud, property damage, lawsuits, etc.)
- Operating Income: This is also called EBITDA (earnings before interest, taxes, depreciation, and amortization). Subtract OPEX from gross profit to get your business's operating income.
- Interest Income: The interest earned from investments, bank accounts, etc.
- Interest Expense: The interest incurred from loans, purchases on credit, etc.
- Depreciation and Amortization: Factor in depreciation, or the loss of value from tangible assets such as vehicles, and amortization, (i.e. the cost of intangible assets like permits).
- Other Income: As needed.
- EBT (earnings before taxes): Find the sum of operating income and other non-operating expenses or income.
- Income Taxes: Report income tax expenses here if you don't report business income on your personal income statement.
- Owner’s Salary: As needed.
- Earnings Per Share: The amount your shareholders would receive if you paid out of net income.
- Net Income: On the bottom line, you'll calculate net income, or income after all expenses and profit are tallied.
You hope to see that your business is operating at a profit, but that might not be the case, especially if you're starting up.
If you do see a profit, remember that P&L statements don't include everything you need to consider—that's where cash flow statements and balance sheets come in.
What isn’t shown on profit and loss statements?
Profit and loss statements capture a lot of data, but they don't cover all financial aspects of your business. Revenue, for instance, doesn't translate to money received if you allow customers to pay with credit.
There are other items not shown on a P&L which a balance sheet accounts for.
- Assets: Cash on hand, inventory, accounts receivable, etc.
- Liabilities: Loans, wages payable, credit card payments, etc.
- Equity: Owner investments, etc.
A cash flow statement bridges the P&L statement and balance sheet, accounting for operating, investing, and financing activities over time.
Example of a profit and loss statement
We’ll use Apple to explore a real-world profit and loss statement. (As a reminder, a P&L statement is also called a statement of operations.) It’s helpful for any business owner to see the variety of ways that companies organize their financial data.
Instead of providing gross revenue on the top line, Apple lists net sales and cost of sales to calculate gross margin. Next, expenses are categorized into two large buckets: research and development, and selling, general and administrative. A smaller business may want to use more categories to track spending by area and gain more insight.
On the “bottom line” is net income, where you can see that Apple operated at a profit all three years. When listing losses on these reports, it’s common to put the amounts in parentheses or brackets. This indicates that the number should be subtracted—and also makes it easier to see losses at a glance.
Finally, Apple provides information on stock earnings, but not without the help of another financial statement. You’ll use the equity section of your balance sheet to find the number of shares, and then calculate earnings per share. There are many ways to prepare a profit and loss statement, which we’ll cover next.
Preparing a profit and loss statement
If you or your accountant is using business accounting software, the standard reports should include a profit and loss statement. With a Brex account, you can export or print your financial statements in seconds.
If you don't use accounting software, we broke down the most popular options in our podcast reviewing accounting software.
Alternatively, there are free profit and loss statement templates software that businesses typically use—like Excel templates and QuickBooks Desktop templates.
We do recommend online software over desktop software because online platforms can integrate with other helpful business tools. Some bank accounts with built-in expense management software can integrate directly with your accounting or bookkeeping software.
As many business owners have learned, there's more room for error when financial data is spread among paper, online documents, and desktop-based tools. By using online accounting software—or hiring a financial analyst who does—you'll also save time on manual input and re-entry.
How do you use a profit and loss statement?
Once you know the terminology, a profit and loss statement is a reasonably straightforward report.
A business owner or accountant can prepare and analyze a P&L statement to recommend changes and keep stakeholders and investors up to speed. If you don't work with an accountant or aren't comfortable managing financial reports, consider outsourcing accounting so you still have access.
If you're a new business owner, it might be beneficial to prepare P&L statements on a monthly basis. That way, you can find opportunities earlier and adjust faster.
If your business is so new that you don't have enough data to create a current P&L statement, there's another option. You can build a pro forma profit and loss statement and make educated guesses by categories while being conservative with predicted profits and generous with costs.
After you’ve been operating a while, you can track year-over-year growth, too. Here are a few other ways to use a profit and loss statement:
- Determine a profitable yet competitive price for your products.
- Forecast future financial health, sales, expenses, and profits/losses.
- Be prepared to pitch to investors at any time with consistent, accurate financial reports.
A profit and loss statement is a go-to report for understanding a company's ability—and potential—to generate revenue, manage expenses, and become profitable. Together with a cash flow statement and balance sheet, you'll get a complete picture of your business's financial standing.