How to Prepare a Profit and Loss Statement: The basics
Imagine for a moment, that you went to a doctor to get a checkup.
Only they didn’t actually give you a checkup; they simply looked you over quickly, handed you a few types of medication, and offered a few random suggestions all based on your physical appearance.
No tests…
No reports…
…nothing.
Now, imagine that you continued to go about your life taking these medications and adhering to these suggested guidelines based on the guesswork of this so-called doctor.
It’s hard to imagine what might happen.
Avoidable complications? Greater instability? Even…death?
Of course, this sounds ridiculous. No one in their right mind would ever live their life this way. Nor would they run their business like this.
However, if you’re running your business without a profit and loss statement– that’s exactly what you’re doing.
What is a profit and loss statement?
A profit and loss statement (also referred to as an income statement or just P&L) is a financial report that shows a company’s revenue and expenses during a particular time period along with the gross profit (or net income) calculated from adding the two together.
In short, a P&L is a detailed report on your company’s health which you can then use to fix problems and make improvements (unlike that sketchy doctor…). However, it’s used for much more than that including qualifying for a business loan and acquiring investors.
In fact – The IRS makes you create one every year when you file your taxes. So without knowing you might have already have one from last year.
Why should I create a profit and loss statement?
In general, a profit and loss statement helps show you where the company is going before it gets there. As mentioned, it offers a detailed report on the health of the company and this has several important benefits.
Most notably, a P&L statement allows you to do 2 things:
- Make adjustments if things look off-course
- Maximize your profit if things are already going great
No matter where you are in your business, a profit and loss statement will help you optimize your process so that you stay on track and can maximize profits.
In addition, a profit and loss statement is the only financial statement required by the IRS, so you might as well invest the time and effort necessary into producing an accurate and detailed statement as it can very well help move your business forward.
How to prepare a profit and loss statement
Here’s how to complete– and benefit from– a profit and loss statement (the 3,000-foot view):
- Calculate revenue
- Calculate expenses
- Calculate profit
- Study the numbers
Pretty straightforward, right? It gets more complicated, but just remember that this is the basic idea.
You want to get an accurate calculation of your gross profit (or net profit, depending on how you’ll be using your P&L), study those numbers, and then use them to improve your cash flow and overall process. And don’t worry, if you’re unfamiliar with any of the terms I just mentioned, we’ll talk more in a bit about what each of those things are.
Let’s dig into more detail. But, first, there are two very important points you need to keep in mind before we begin:
- You need to track your revenue and expenses accurately: If you’re not tracking your revenue and expenses accurately, it will be impossible to produce an accurate profit and loss statement, if at all. Plus, an inaccurate P&L statement can be just as, if not more, damaging than not running one at all because you’ll be taking action based on false information. This isn’t complicated, though. You can use something like Quickbooks to partially automate the process for you. Either way, make sure this is implemented before attempting to run a P&L. The SBA has a great guide on how to track your revenue here
- You need to specify a period of time: A profit and loss statement is always done within a specified time period, so identify what that period of time is for you before moving forward. Examples of this could be a P&L for all of 2018 or a single 3-month quarter.
Got it? Great. Now let’s talk about how to prepare a profit and loss statement:
*Note: Keep in mind that you can use software like Xero or Quickbooks to not only track revenue and expenses (as mentioned above), but also to generate your P&L or income statement for you with much less work and hassle as compared to doing it manually.
1. Calculate revenue
The first step is pretty simple– calculate your revenue for the specified time period. Revenue is defined as the total amount of money your business generated during a specified period of time. Typically, this money is generated by the selling of your products and services.
2. Calculate expenses
Next, it’s time to calculate your expenses. Yay…
This includes everything, most notably, the various costs to produce and sell the goods or service which you used to generate revenue.
Examples include:
- Marketing & advertising
- Raw materials (if you make a product)
- Office supplies
- Payments to contractors
- Etc.
Gather any all relevant expenses, even the odd ones you’d be likely to forget such as returns and refunds. As mentioned earlier, the usefulness of your P&L report will be based on how accurate it is, so make to include everything here.
3. Calculate profit
Now is the fun part. Take your two calculations and put them together to get your gross profit (I.E. before taxes):
Revenue – Expenses = Gross profit
Keep in mind that this is a bit of a simplification of what most P&Ls look like. In all likelihood, your P&L will look something more like this:
Revenue
– Cost of goods sold (product or service creation-related expenses)
___________
Gross profit
– Selling / administrative expenses (expenses related to moving or maintaining the product or service)
___________
Net operating profit
– Income taxes
________________
*Net profit (or loss)
Net profit or loss, depending on if you ended in the positive or negative for the selected time period, is the final number your P&L report will generate and it is the actual profit the company generated (or money it lost).
However, keep in mind that gross profit (profit before additional non-product-related expenses) and net operating profit (the money the business has left after all expenses are paid for) are the numbers that you’ll typically be most interested in as that’s what is in your control to change.
4. Study the numbers to understand the profit and loss statement
Now that you’re profit and loss statement is complete, it’s time to study the numbers. Take time to pour over every detail from gross profit to net profit to get an idea of the overall health of your business.
The primary thing to look for here is weaknesses. Is your cost of goods sold too high? Are other expenses getting a bit out of hand? Is there a period in the year where revenue consistently increases by a noticeable margin? Do you know why?
The more time you take to study the information in your P&L the better you can take advantage of the information you’ve uncovered.
Now that you’re done studying your new P&L, all that’s left is to take action based on the information you’ve found. Keep in mind that your profit and loss statement is only useful to the degree that you use the information (or the statement itself, in the case of acquiring a business loan), so take action and make the most of the insights you’ve uncovered.
No matter your business goals, whether it’s to identify room for improvement in your budget or cash flow, apply for an SBA Loan or other type of business loan, or attract investors, a profit and loss statement is a useful tool for moving your business forward. Use your P&L to obtain an accurate gauge of the health of your business and move forward towards profitability.
To see a full list of Microsoft Excel’s profit and loss statement templates, click here: Microsoft Excel profit & loss statement templates.
