Profit and Loss Statement: Definition, Formula, and Examples - PRN (2024)

P&L Statement for Businesses

A business uses various metrics to gauge its financial success. On the most basic level, financial success is measured by the gap between income and expenses. The higher the profits, the more money a company has available to reinvest in growth efforts or disburse to shareholders and owners. The profit and loss statement shows how your business manages income and costs.

A profit and loss statement, which details all expenses and revenue over a given period, provides a big-picture look at the financial health of a company. It is one of three primary financial reports that measure a business’s success. The others are a cash flow statement, which provides a detailed look at the flow of money in a business operation, and a balance sheet, which includes factors like asset value, equity, and liabilities.

Profit and loss statement calculations can be complex because a business often has different expenses. If you engage in invoice factoring, for example, you need to carefully add the profits and fees for each invoice.

Here is what you need to know about to calculate profit and loss statements correctly.

What Is a Profit and Loss Statement?

Some businesses call a profit and loss statement an “income statement” or “statement of operations.” The statement is a financial report that summarizes a company’s revenues and expenses over a given period. Most companies prepare them quarterly, and they make an annual report at the end of the fiscal year.

Investors, lenders, shareholders, and others who look at this report use it to see how well the company manages expenses and how successful it is at increasing revenue.

Every public company is required to issue a profit and loss statement as well as a quarterly and annual balance sheet and cash-flow statement.

Small businesses do not need to follow the same reporting requirements. However, an owner can prepare an income statement to show to stakeholders, attract new investors, and use it when applying for a loan. The business owner can also rely on the statements to find trends and look for areas to increase revenue or cut spending in the future. The information can help inform strategic decisions for the next quarter or year.

How Profit and Loss Statements Work

The profit and loss statement shows how your business manages income and costs. Like the cash-flow statement, it shows changes in your accounts over a set period. However, cash-flow reports focus solely on the amount of money coming into and leaving the company. A profit and loss statement looks deeper into revenue and expenses.

A profit and loss statement shows you how the money is flowing within your business. It allows you to see where the increases or decreases are originating.

For example, perhaps an investor looks at your profit and loss statement and sees that your profits were limited for the quarter. If they look closely at the data, they can see whether your overall profits were limited because of uncontrolled expenses or lagging profits or because you reinvested earnings to grow your business.

Types of Profit and Loss Statements

A profit and loss statement goes by other names, as well. It can be called an income statement, a statement of operations, and a statement of financial results and income. These terms all refer to the same document.

However, there are two different types of profit and loss statements. One is a cash basis statement, and the other is an accrual statement. These two options use slightly different methods for calculating revenue and expenses. Most small businesses use the cash method, while larger companies typically rely on the accrual method. Here is what you need to know about the differences between these two methods.

Cash Method

The cash method is common for smaller businesses that rely on cash transactions. With this method, you record the profit and loss when money changes hands. In other words, your business does not record the income or payout until it gets made.

For example, if a payment for an invoice from June is made in July, the statement will show the money coming in July even though the earnings are from June operations.

Accrual Method

The accrual method records income and expenses as soon as they are earned or incurred. Using the above example, the invoice for June services would be recorded on the statement in June even though the money was not yet in the business’s bank account.

Larger businesses that do not have to rely on readily available cash for transactions, payroll, and other expenses can use this method to accurately reflect their finances.

How Often Should You Update Your P&L Statement?

To ensure accurate financial monitoring and cater to the requirements of investors, it is recommended to update your profit and loss (P&L) statement regularly. The frequency of updates can vary depending on the specific circ*mstances of your business.

For established businesses, updating the P&L statement on a monthly or quarterly basis is generally sufficient. This regular monitoring allows you to track profits and make informed decisions. However, if your business is in its initial stages, a more frequent update cycle may be necessary to closely monitor financial performance and maintain a clear understanding of your profitability.

In addition to regular updates, certain events or triggers may prompt the need for more immediate P&L statement updates. For instance, the arrival of tax season or the launch of a new product may necessitate an update to accurately reflect the impact of these factors on your financials. Similarly, expanding into new geographical areas or encountering new competitors can also require adjustments to your P&L statement, particularly if there is a notable impact on profits.

It is important to note that updating your P&L statement should not be solely driven by negative trends in profitability. If your profits are declining, it is crucial to promptly analyze the situation and consider potential shifts in your marketing strategy. By keeping a close eye on your financials through regular updates, you can proactively address any challenges and optimize your business’s performance.

How To Create a Profit and Loss Statement

In basic terms, a profit and loss statement is the sum of revenue from all sources minus the cost of producing or acquiring goods or offering services and other expenses.

Here is a closer look at the different components of this financial report.

• Calculating revenue: In a profit and loss statement, you need to calculate the total revenue for the business. This includes money received (cash method) or earned (accrual method) from business activities during the month, quarter, or year. You also include profits from the sale of equipment and other earnings.
• Calculate operating costs: The operating costs are the money that you need to spend to produce your products or offer your services. The expenses will vary depending on your business.
  • If you manufacture products, your costs will include materials, labor, warehouse operating expenses, and equipment.
  • You sell products, your expenses will include the cost of wholesale products and any shipping-related expenses.
  • If you have a staffing agency, your expenses will include payroll and any related expenses. If you rely on a factoring service to pay your employees, the percentage that you pay for this service will be part of the operating expenses. The use of a factoring service can also affect when you record the expenses and profits if you use the cash method for your calculations.
  • Other expenses, such as marketing, are also considered operating expenses. You would also include fees if you use a factoring service to purchase supplies.
• Calculate profits: The gross profit for your company over the given period is the amount of revenue minus the total operating costs.
  • In some industries, it makes sense to separate the cost of goods and the cost of operations. In an e-commerce business, for example, the gross profit would be the revenue after subtracting the cost of goods. The operating profit would be the revenue when you subtract both the cost of goods and the cost of operations.
• Add taxes, interest payments, depreciation of assets, and the cost of intangible assets (also known as amortization).
• The gross profit minus the cost of taxes, interest, and depreciation leads to the final figure, the net profit for the company. If you incurred a loss instead of a profit, this final figure will be negative.

While the net profit is the final number on a profit and loss report, all the numbers that come before it help to create a complete picture of the financial health of each aspect of a company’s operation.

Profit and Loss Statement Formula

The formula of a profit and loss statement is:

Net Profit and Loss = ((Total Revenue + Additional Income) – (Cost of Products and Services + Operating Costs)) – (Interests + Taxes + Depreciation + Amortization).

You need to make sure that the figures that you use for the calculation all come from the required period and that you use the same method (cash or accrual) for each figure in the equation.

Profit and Loss Statement Examples

Here is an example of a profit and loss statement for a medical staffing company.

This example shows a staffing company that earns revenue and reaches the break-even point after subtracting expenses. An investor might realize that this is a startup that can become profitable by increasing profits and cutting operating costs. Meanwhile, the business owner can look at this report and see areas to target for improvement.