Profit and loss. Two of the most straightforward ideas in business, especially compared to the complexity of business accounting, are still utterly vital to a company's survival.
The intertwined concepts of P&L are the wheels on the vehicles of your company's finances. They are probably the most simple functioning part, but you won't get very far if they aren't working correctly. This is the core of any financial activity and is fundamental to running a company, whether it's a small business or a global organisation.
Understanding and tracking your profit and loss is critical to the health of your business. This is where your P&L statement comes in! A profit and loss statement (also called an income statement or earnings statement) is a document used to track a company's revenues, expenses, and resulting profits or losses over a specific period. It includes items from a cash basis as well as an accrual basis to see exactly how much the company makes.
Understanding and tracking your profit and loss is critical to the health of your business.
It's important for every business owner to analyse their P&L statements often in order to identify where they are making money and where money is being lost. A P&L statement can help you make decisions about what investments are wise to pursue, where production costs may be too high, how to generate cash flow, and other areas of financial management that your business needs to pay attention to. In turn, it will help you gain a better insight into revenue as well as manage expenses, interest expenses, interest payments and more.
This article down the components of a P&L statement and will additionally discuss why understanding your P & L statement is essential for the long-term success of your business.
Profit and loss statement definition
As mentioned, this is a financial document that summarises your income, expenses, and profits over a set period of time. It's also referred to as an income statement or earnings statement.
Generated on a weekly, monthly, quarterly, or even annual basis, depending on the needs of the specific business, a P&L statement enables business owners to evaluate their financial performance. It also allows them to identify areas for improvement, such as reducing expenses related to ongoing business operations or increasing sales and net revenue.
Since promoting growth, increasing sales, stabilising cash flow, and controlling both operating and non operating expenses are critical to maintaining a healthy business, the P&L statement is invaluable for any organisation.
It helps business owners assess their current financial standing and make more informed decisions about future investments, the company's assets and other key matters.
What does a p&l statement include?
Profit and loss statements can be generated by virtually all accounting software and can be used by any service business. They generally include the following:
- Revenue: This is all the money you have generated from selling products or services over a specified period. It includes any additional income sources like investments or sales of assets to show the net revenue.
- Gross Profit: This is calculated by subtracting the cost of goods sold (COGS) from total revenue. It represents how much profit your company has made before deducting other expenses.
- Operating Expenses: These are all of the costs associated with running a business, such as salaries, rent, utilities, taxes, and insurance premiums.
- Net Profit/Loss: This is calculated by subtracting your operating expenses from your gross profit. If the number is positive, it's a profit; if negative, the net income shows a loss.
- Cash Flow: This is the change in your company's bank balance throughout the period being reported on. It includes any payments or receipts of money from activities such as investments, debts, dividends, and other activities.
Now that you have a better idea of the components of a p&l statement, you should look at what the analysis of those components can tell you about the health of your business and how it can subsequently be used for increasing revenue or boosting the firm's profit margin.
What does your profit and loss statement tell you?
The insights provided by a P&L statement are numerous. Here are a few of the key points you'll find:
- Gross Profit and Net Profit - Your gross profit is the total amount of money that your company has made from sales minus your costs of goods sold (COGS). Analysing this figure will let you know how much of a premium you charge for your products or services.
- Operating Expenses - This part of your P&L statement tells you about all the expenses associated with running your business, such as rent, salaries, utilities, and other overhead costs, enabling you to accurately assess how much money you are spending relative to your sales.
- Revenues and Profits/Losses - The top line of your P&L statement summarises the total revenue your company has generated during the reported period. This is then compared to total expenses; any profits or losses will be calculated. Keeping a close eye on this figure will help you identify trends in your business performance and make adjustments when necessary.
- Cash Flow - Your cash flow statement also gives you an insight into the change in your company's bank balance throughout the period being reported on, as well as other information, such as how much money was spent on debts, investments, dividends, and other activities. Since cash flow is the lifeblood of any business, this section is particularly important.
Understanding your P&L statement is key to making sure that your business runs smoothly and makes a good return at the end of each period.
By looking into what makes up these numbers, you can identify areas where money can be saved or made, how much you should be investing in certain areas, and how successful different strategies for increasing sales or reducing costs have been.
This can then be used to inform decisions in the future, helping your business to reach its goals and objectives.
What does a profit and loss statement track?
P & L statements are an excellent tool for tracking the financial performance of your business over a set period of time. By comparing your income and expenses, you can clearly see how much money is coming in and being spent.
Let's look at a quick example:
Company A is a small retail shop. Their P&L statement for the year looks like this:
Revenue – $200,000
COGS (Cost of Goods Sold) – $90,000
Gross Profit – $110,000
Operating Expenses – $30,000
Net Profit – $80,000
This example shows that Company A had total revenues of $200,000 in the year and spent $90,000 on COGS. This means that their gross profit was $110,000 ($200k - 90k). After deducting operating expenses of $30,000, they were left with a net profit of $80,000.
By analysing the P&L statement, Company A can see that their gross profit margin is 55% ($110k/200k), and their profit margin (net) is 40% ($80k/200k). This lets them know how well they perform relative to other industry businesses.
These kinds of insights are invaluable for any business, as they enable you to make more informed decisions about allocating resources and improving processes.
How do you write a profit and loss statement?
Despite its critical importance, writing a P & L statement is surprisingly simple. Let's break it down into steps:
- Step 1 - Track your revenue
The first step is to track your revenue, from sales of products and services to investments or assets.
- Step 2 - Calculate your COGS (Cost of Goods Sold)
Next, calculate the total cost of producing the goods or services you sold. This will give you an understanding of how much it costs to produce what you sold.
- Step 3 - Calculate your gross profit
Subtract the cost of goods sold (COGS) from total revenue to calculate your gross profit. This will give you an idea of how much money you have made before deducting any other expenses.
- Step 4 - Calculate your operating expenses
These are all of the costs associated with running a business, such as salaries, rent, utilities, taxes, and insurance premiums.
- Step 5 - Calculate and track cash flow
Finally, calculate the change in your company's bank balance throughout the period being reported on. This will take into account any payments or receipts of money from activities such as investments, debts, dividends, and other activities.
- Step 6 - Calculate net profit/loss
Subtract your operating expenses from your gross profit. If the resulting number is positive, you have made a net profit; if negative, you have a net loss.
- Step 7 - Adjust for other income or expenses
Finally, adjust your profit/loss for any other income or expenses that did not appear on the P&L statement. This could include depreciation or amortization charges, one-off gains or losses, and interest or dividends from company investments.
These seven steps should give you a comprehensive picture of your company's financial performance over a set period of time and help you understand the financial statement.
Why is analysing your profit and loss statement crucial?
Understanding the intricacies of your business's finances can be daunting, but it is essential if you want to make sound and informed decisions.
Analysing your P&L statement will let you know where you are making or losing money, enabling you to identify areas where improvements can be made in order to increase profits and reduce costs.
It also gives you the information you need to assess the success of different strategies and make decisions about allocating resources, allowing you to plan for the future effectively.
Simply put, by understanding and analysing your P & L statement, you can ensure your business is running as efficiently and profitably as possible.
Profit and loss statement FAQS
This is one of the main financial statements for gaining insight into the company's ability to make more money than it spends. However, it's important to understand how it compares to other financial statements and helps build a clearer image of the organisation's financial position.
Do all businesses have to prepare profit and loss financial statements?
Any public company, limited company or partnership where members are limited companies, must file profit and loss statements for each year of operation. However, sole traders and many partnerships do not require a formal account. Instead, they will produce other financial statements to calculate tax expenses and payments. Still, the many benefits of P&L statements mean that many small business owners file them even when it isn't a requirement.
Is a profit and loss statement the same as an income statement?
Yes. A P L statement may take many names including income statement, operating statement, revenue statement, statement of income, or statement of operations. Ultimately, it will show the net income as the bottom line. This insight into the operating income covers cash and cash equivalents to show how much cash the business makes as well as the company's profit in the specified time.
Is a profit and loss statement the same as a cash flow statement?
Like the p & L statement, cash flow statements are used by both private and public companies to highlight changes in financial health compared to previous periods. However, it does this by looking at the net revenue and net expenses incurred to determine net income profits or losses for the specified time. It's important to remember that cash flow can be generated without necessarily making a profit, though. Accounting software and strategies like the accrual method accounts should be used to gain a better insight.
What are the differences between a profit and loss statement and a balance sheet?
No. A balance sheet is a financial statement that simply serves to provide a snapshot of the company's financial health at a specific date (often the last day of the fiscal year) by listing the total assets and liabilities. Therefore, it highlights the company's financial strength by comparing these two clear figures. Conversely, P L statements show income gained, expenses incurred, and the company's profitability over a specified period. So, this statement shows cash flow and debt financing capabilities.
The foundation of sound financial practice
By understanding which expenses are essential to running your business, and where you can make cost savings, you can improve your bottom line and ensure that your business is a financial success.
This is particularly important at a time when many SMEs are feeling the effects of the current economic downturn, cost of living issues, and the late payment crisis.
While accurate P&L reporting is vital, there are other ways to solidify your cash flow and make sure that your business is running as efficiently and profitably as possible.
Chaser's award-winning accounts receivables software and automated payment reminder system can help you to get paid on time. This kind of tool is invaluable for SMEs as it takes the hassle out of chasing payments, leaving them free to focus on what they do best - running their business.
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