Running a business can sometimes feel like you’re lost at sea without a navigation chart and no land in sight.
Are your guardrail metrics holding up? Are your operating costs still low? How do you know if you’re on track to hit your Q4 target?
Instead of guesswork (or looking at nautical charts), profit and loss (P&L) statements can lead the way.
These reports give you a snapshot of business earnings and expenses over a particular period of time – helping you gauge your company’s health and decide what improvements to make.
Let’s dive into how you can get the most from your profit and loss statement.
What Is a Profit and Loss Statement?
A profit and loss report is a financial statement that summarizes the expenses, costs, and revenues of an organization during a particular period of time, often a quarter or year.
Every public company issues P&L statements quarterly and annually, along with their balance sheet and cash flow statement. By comparing P&L statements from different time periods, you can evaluate your company’s financial wellbeing.
What Is the Difference Between a P&L Statement and a Balance Sheet?
A balance sheet (or position statement) represents a company’s assets, liabilities, and the capital of shareholders on a specific date.
P.S. Grab our free Balance Sheet template here
On the other hand, a P&L statement (or income statement) shows the company’s revenue and business expenses incurred during the financial year.
Typically, a balance sheet is prepared at the end of a month, quarter, or fiscal year, while a P&L statement is generated every quarter or year.
Read Next: The Complete Difference Between a Balance Sheet vs Income Statement
Are All Companies Required to Create P&L Statements?
A business’s leadership team typically has to produce several years of profit and loss reports when applying for a loan, taking on investors, or trying to sell the company. They also have to send profit and loss statements to their tax preparer when filing income taxes.
What Is in a P&L Statement?
A profit and loss statement contains two primary components: the income earned and the expenditures during a given period.
You would then break down these two components into smaller parts that pertain to your business.
- Revenue: The amount of money a business makes during a reporting period
- Expenses: The amount of money a company spends during a reporting period
- Cost of goods sold (COGS): The costs that a business incurs to make its products or platform
- Gross profit: Total revenue minus COGS
- Operating income: Gross profit minus operating expenses
- Income before taxes: Operating income minus non-operating expenses
- Net income: Income before taxes minus taxes
- Earnings per share (EPS): Net income divided by the total number of outstanding shares
- Depreciation: The value that assets lose over time
- EBITDA: Earnings before interest, taxes, depreciation, and amortization
You can also break these components down into more line items depending on the company’s policy and how detailed the statement of profit and loss is.
How to Create a Profit and Loss Statement
A P&L can be created using accounting software — specifically, an FP&A platform – or a typical Excel spreadsheet.
While you may be comfortable using Excel to prepare P&L statements, automating these reports with an FP&A platform is faster. It also improves accuracy since manual entry often leads to errors. You can feed data directly from your centralized database, and the software produces the income statement automatically, leaving you with more time to drill down and surface new insights.
Regardless of the tool you use, here are the steps you need to follow:
- Choose between the cash and accrual method.
- Choose a time frame.
- List revenue.
- Calculate direct costs.
- Calculate gross profits.
- Calculate the operating and non-operating expenses.
- Calculate your net profit.
Choose Between the Cash and Accrual Methods
When you prepare a profit and loss statement, you can use one of two methods—cash or accrual.
- Cash method (or cash accounting method): Record the income or expense only when you receive the money or when it leaves your bank account.
- Accrual accounting method: Record the revenue when it’s earned. If you expect to receive income in the future, you have to record it even before you receive it in your bank account.
While the cash method is simpler to implement, it is not used that often because it isn’t an accurate report of a business’s financial health.
Say your business closed a deal in Q3 but, due to payment terms, you don’t receive the money until Q4. If you use the cash method, it may look like you haven’t hit your sales target. However, with the accrual method, you would record the sales in Q3, which is a more accurate representation of the company’s earnings.
That’s why the Generally Accepted Accounting Principles (GAAP), a framework adopted by nearly all publicly traded companies, recommends the accrual method.
Choose a Time Frame
You can choose to create a P&L report monthly, quarterly, or annually, but make sure you select a time frame that doesn’t overwhelm you with so much data that you’re unable to uncover any trends. Typically, anything less than a month or over a year will fail to reveal any meaningful insights.
List Revenue
Typically, your revenue equals your sales. But this can also include income from other sources like franchise agreements, rental income or tax refunds. Each source of revenue gets a separate line item. Once you’ve put down all your sources, add them up to calculate your gross revenue.
Calculate Direct Costs
Direct costs or costs of goods sold refer to how much it costs to make the goods you sell and goes under your expenses.
Here’s a formula that can help you calculate COGS:
“Cost of goods sold = beginning inventory + purchases – ending inventory”
Calculate Gross Profit
Subtract your direct costs from your total revenue to get your gross profit and put it under your revenue.
You can also calculate your gross margins with this formula:
“Gross margin = { [Gross revenue – direct costs] / gross revenue } x 100”
Calculate Operating Expenses and Non-Operating Expenses
Operating expenses (OPEX) are any expenses necessary for your business that aren’t direct costs or any money that doesn’t go directly into creating goods or supplying services.
Depending on the type of business you run, operational expenses could include:
- Monthly utilities
- Business internet
- Phone plans
- Hardware and equipment
- Marketing costs
- Office supplies
- Building maintenance
- Repairs
Non-operating expenses are categorized as one-time expenses like legal fees or interest on a business loan.
Calculate Your Net Profit
Here’s the formula you need to calculate your bottom line:
“Net profit = Gross Profit – Total Expenses”
Your net profit determines whether or not you’re running a profitable business. List your net profit and net profit margin at the end of the P&L statement.
How to Analyze a Profit and Loss Statement
When looking at the profit and loss report, you may use one of the two most common methods—vertical analysis or horizontal analysis.
- Vertical analysis: In this method, you list each line item as a percentage of a base figure instead of an exact amount in dollars. This reporting helps you understand how the line items relate to each other. For instance, you can use percentages to understand how individual expenses compare to the total operating expense.
This type of financial analysis can help you analyze how the performance metrics have fared over a period of time.
- Horizontal analysis: In this method, you represent line items as exact figures. Instead of looking at how line items relate to each other, you compare items over multiple reporting periods. That’s why investors and analysts prefer horizontal analysis—it helps identify patterns and trends over time.
Although vertical analysis makes a company’s financial documents consistent with GAAP, both forms of financial analysis are useful—they surface different yet helpful insights that inform your decisions.
Free P&L Statement Template (+ Examples of P&L Reports)
Preparing an income statement for the first time? Download our free Excel-based profit and loss statement template to create your first P&L report today.
Here’s a quick glimpse of what the report template looks like:
And if you’re unsure of how to fill up the line items, here are a few real-life examples of profit and loss statements you can peruse:
- Walt Disney’s annual income statement
- Netflix’s Q1 2022 financial statement
- HubSpot’s annual income statement
Automate Your P&L Reporting with Datarails
Create automated financial reports with a cloud-based FP&A platform like Datarails.
The best part? You don’t have to change the way you work to improve your processes. Datarails is an Excel-based solution, so you can use your existing spreadsheets and not have to learn a completely new interface.
Datarails fits itself to you, not the other way around.
Want to see Datarails in action? Request your demo today.
