A profit and loss statement, also known as an income statement or statement of operations, is a detailed financial statement showing a business's total income and expenses. The income and expenses will then help calculate the business's profit and losses.
What’s the Importance of This Statement?
The P&L report shows the net profit or loss of a business based on the revenues and expenses, indicating the financial health of the company. It also indicates the company’s ability to increase profits by cutting down costs and holds important information to make future projections.
Altogether, the income statement helps allocate resources and prepare budgets through forecasting and targeting. You can also calculate your working capital with it. The IRS also requires the statement for assessing taxes based on the profits of the business.
How Many Types of P&L Statements Are There?
There are two types of P&L statements: one prepared using the cash method and another prepared using the accrual method. You can use one of the methods based on the type of transactions you carry out in your business.
The cash method, also known as the cash accounting method, is used by businesses whose transactions simply depend on receiving and paying by cash. It’s a very simple method used by small companies.
A business records revenues when it receives cash payments and records liabilities or expenses when it has to pay bills and liabilities with cash.
Businesses using the accrual method record their revenues when they actually receive the payment and not when the transaction occurs. In a similar manner, they record liabilities even when they haven’t paid bills or carried out expenses yet.
What Components Are Needed to Create a P&L?
To create a statement of operations, you must know which components go into the reports. Each of these components will carry more elements, which will further help you determine your operational costs, net income, and the profit you made or the loss you incurred.
The revenue section of the P&L statement shows all the parts of the business that brought in revenue. It contains things such as sales, sales returns, discounts, and allowances.
2. Cost of Goods Sold (COGS)
COGS covers the company's manufacturing costs of raw materials and direct labor. Overhead cost is involved too in this section. It may vary if your company provides services rather than goods or provides both.
3. Gross Profit
Gross profit shows how much the company has gained or has incurred losses. You can find this out after subtracting COGS from revenue.
4. Operating Expenses
The section involving operating expenses is the most comprehensive part of the P&L statement, as it contains all the expenses that go into operating the business. The elements commonly reported under this component are:
Maintenance and repair costs
5. Operating Profit
You can derive the operating profits, or losses for that matter, by subtracting total operating expenses from gross profit.
6. Other Income and Expenses
Any other income you get from the business, such as interest and dividends. Other expenses related to the business that don’t fall under any category can also be reported in this section. These components also go into calculating the profit or loss of your company before taxes.
7. Net Profit
This shows your business's net profit or loss after deducting tax expenses from the profit before taxes.
How Should Out Carry Out the Calculations?
Creating the P&L statement consists of eight steps:
Calculating the revenue;
Calculating the cost of goods or services sold;
Subtracting the cost of goods or services sold from the revenue to get gross profit;
Calculating the operating expenses, which include rent, travel, utilities, equipment, etc.;
Subtracting operating expenses from gross profit to find the total operating profit;
Adding the additional income from dividends or interests with operating profit to derive the earnings before interest, taxes, depreciation, and amortization (EBIDTA);
Calculate interest, depreciation, taxes due, and amortization;
Subtract them from EBIDTA to drive your net profit.