Profit and Loss Statement – Importance, Components, Calculation

Is your business profitable? This is, without a doubt, one of the questions every businessperson must ask themselves. If the expenses are greater than the income, it is not very good news for your business. Hence, it is crucial that you are aware of the profits and losses, which is why a P&L statement is important for every business. This article will explain the Profit and Loss Statement, why it is important, and how to create a P&L statement for your business.

Content

• What is a P&L Statement?
• Importance of a P&L Statement
• Key Components of a P&L Statement
• How to Create Your P&L Statement?
• Key Takeaways

What is a P&L Statement?

A profit and loss (P&L) statement is a type of financial statement that reflects a summary of revenues, costs, and expenses incurred in a given period. This period is usually a quarter or fiscal year. A P&L statement offers information about the ability or inability to generate profit by increasing revenue, reducing costs, or both. 

P&L (Net profit) = Income – Expenses

P&L statements are often presented on a cash or accrual basis. These P&L statements help to analyze a company’s financial health.

Importance of a P&L Statement 

Determining the performance of a business – P&L statements help measure any business’s success. It enables business leaders and managers to determine which tasks are helping the business to gain more ROI or where they are losing money.

Make informed business decisions – It also helps business leaders and managers make decisions about allocating resources, such as investing in new equipment or hiring additional staff.

Attracting investors – P&L statements are also important if you apply for a small business loan or seek funding from investors. These statements will help the lenders and investors evaluate your income against the expenses, debts and taxes and understand that your business is viable and that providing financial assistance is safe.

Meeting Legal Requirements: In many countries, businesses must legally submit financial statements, including a P&L statement, to regulatory bodies. In case of failure to comply, they must pay penalties.

Key Components of a P&L Statement 

A profit and loss statement varies from business to business, depending on the type of business and its complexity, such as whether you sell items rather than services, have multiple sources of income, or have many expenses. Listed below are some common components of the P&L statement.

Income

Income represents the net sales or receipts for the accounting period. It covers income generated by the entity’s main business activity and non-operating income.

Price of Items Sold

The direct expenses incurred to manufacture items or provide services to customers, including labour and direct materials, are known as the cost of goods sold (COGS).

Gross Profit

Gross profit, often referred to as gross income or gross margin, is defined as net income minus the cost of goods sold.

Operating Expenses

Operating expenses are administrative, overhead, and selling costs associated with running a business for a set period. This covers rent, payroll, utilities, office supplies, and any other indirect expenses associated with running a business. It also includes non-cash expenses, such as depreciation.

Operating Income

Earnings before taxes, depreciation, interest, and authorization are called operating income. To determine operating income, subtract operating expenses from gross profit.

Other Income and Expenses

While optional, many businesses split certain income and expenses on their profit and loss statements. This area typically contains expenses unrelated to normal activities, such as gains or losses from selling company assets, interest income and dividends from investments, and other exceptional or unusual income and expenses.

Net Profit

Net profit is the total amount after deducting all expenses. Subtract your total expenses from your gross profit to calculate your net profit.

This last data is obtained by grouping all the income and subtracting the expenses of the same period. If the number is positive, the business will be profitable; if it is negative, you will have losses. 

How to Create Your P&L Statement?

The profit and loss statement is divided into two parts: 

• Income earned during the statement period 
• Expenses incurred during the same period

To manually create a basic profit and loss statement, follow these steps:

1. Calculate your business income 

Income is the money you receive as payment for your goods and services. They are also defined as “the top line” because they appear first on a company’s Profit and Loss Statement.

To calculate the income of your business, use any of the following formulas:

• Number of units sold x average unit price.

or

• Number of customers served x average price of the service offered.

2. Calculate sales cost 

The cost of your sales will vary depending on the amount of business you do. It is also known as the cost of goods sold. Inventory, raw materials for manufacturing, and additional staff hired to cover a busy period are called variable costs.

3. Determine your gross profit

To calculate gross profit, deduct costs from revenue using the following formula:

Gross Profit = Revenue – Cost of Goods Sold

Once you’ve done the math, you’ll know how much money you need to cover your business expenses after paying for your products or services.

You can also calculate your gross profit percentage by dividing your gross profit by your income using the formula:

Gross Profit Percentage (%) = Gross Profit / Revenue x 100

This percentage shows you how much you spend on products/services. The higher the gross profit percentage, the better. It means that your business is generating profits.

Let’s understand this through an example. We will apply the gross profit formula to solve a hypothetical case:

100 bicycles are purchased from a supplier for Rs. 1,000 each. This means that the direct cost of the product is Rs. 1,00,000 (Rs. 1000×100). 

They are then sold for Rs. 2,500 per unit, generating a total revenue of Rs. 2,50,000 (2500×100)

So, the gross profit (Revenue-Cost) would be Rs. 1,50,000 (Rs. 2,50,000 – Rs. 1,00,000), and the gross profit percentage would be 60%.

4. Calculate your operating expenses

Operating expenses or operating costs are the expenses basis of daily business activities. 

These expenses may include the following:

• Renting your office or store
• Public services: internet, electricity, water and gas
• Staff payroll
• Marketing expenses
• Business trip expenses
• Office supplies
• Insurance

This list should not include taxes or interest on loans. Differentiate them from the costs of your goods and services.

5. Evaluate your operating profit

Calculate your operating expenses and gross profit once you define your operating expenses. Subtract your operating expenses from your gross profit to do this. The result is your operating profit.

Operating Profit/Loss = Gross Profit – Operating Expenses

Operating profit indirectly measures productivity and the company’s ability to generate more profit. Investors closely monitor operating profit to gauge the company’s efficiency trend over time.

6. Adjust other income and expenses

Calculate your EBITDA (Earnings Before Interest, Taxes, Depreciation And Amortization). The most common method of calculating EBITDA is to start with your operating profit, also known as EBIT (Earnings Before Interest and Taxes), and then add depreciation and amortization.

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization.

7. Net profit or loss

This is your bottom line. Net profit is the amount left of your business income after subtracting all expenses and costs using the following formula:

Net Profit/Loss = EBITDA – (Interest + Taxes + Depreciation)

This result will indicate if your business is profitable. You can go one step further and calculate your net profit percentage by dividing your net profit by your net income and multiplying by 100.

Key Takeaways

• A P&L statement correctly indicates your company’s health.
• A P&L statement summarizes a company’s revenues, costs, and expenses in a period.
• A P&L is important when applying for a loan or any funding.
• A P&L lets lenders and investors see your business’s total income, debt load and financial stability.
• Public companies issue P&L statements quarterly and annually, along with balance sheet and cash flow statements.

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