As a self-employed individual, you may not have considered the need to prepare financial statements for your small business. However, there is one financial statement you may be required to prepare for tax purposes, and that is the profit and loss statement the IRS requires from sole proprietors.
Each year when you complete your trusty Schedule C as a self-employed individual, you are in effect creating a year-to-date profit and loss statement of your self-employed activities. You will need to fill out and file the form in a timely manner in order to satisfy IRS profit and loss reporting requirements for sole proprietors.
If you're self-employed, you may also find it beneficial to prepare a profit and loss, or P&L, statement for purposes other than compliance with taxation requirements. For example, if you intend to approach a lender to negotiate financing for your business, you may be asked to provide various financial statements along with your application, including a profit and loss statement.
Profit or loss from business (sole proprietorship): Schedule C (Form 1040)
The IRS requires sole proprietors to use Profit or Loss From Business (Sole Proprietorship) (Schedule C (Form 1040)), to report either income or loss from their businesses. How do you know if the activity in which you're engaged qualifies as a business? According to the IRS, it's a business if:
- Your main reason for engaging in the activity was to generate income or make a profit; and
- You participated in the activity on an ongoing, continuous basis.
Preparing the profit and loss statement for small business
If you answered "yes" to points 1. and 2. above, you'll be required to file Schedule C (Form 1040) with the IRS. The form can be found on the IRS's website, along with detailed instructions for properly completing and filing it.
In general, the IRS permits Schedule C (Form 1040) to be completed using either the cash method of accounting or the accrual method. However, the rules currently require the accrual method to be used for sales and purchases of inventory.
With the cash method, you report income you've actually received during the year, and your deductible expenses are amounts you actually paid during the year. The accrual method requires you to report income in the period in which you've earned it, regardless of when you receive the income. Under the accrual method, expenses are deducted when you incur the expense, even if you don't end up paying the expense during the current tax year.
Change of accounting method
Once you've filed a P&L statement using a particular accounting method, if you want to change the method (regardless of whether you've been using the cash method or the accrual method) you'll need to file an Application for Change in Accounting Method (Form 3115) in order to change to a different accounting method. An IRC 481(a) adjustment also may be required, in order to ensure that income or expenses are not duplicated or omitted.
Profit and loss statement analysis
In addition to being required by the IRS, as a self-employed individual, you may also find it useful to prepare a profit and loss statement for your business if you've applied for financing.
Potential creditors can use your P&L statement to conduct a profit and loss statement analysis. This analysis uses the numbers you provide to aid a creditor in the assessment of the viability and financial health of your business. This is an important assessment, as the result can have an impact not only on whether a creditor will extend credit to your business but also on the amount of credit and the types of payment terms the creditor will offer you.
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FAQs
In fact, as a sole proprietor, you actually aren't obligated to prepare a separate self employed profit and loss statement (though it's highly recommended due to its benefits), since you're effectively completing a year-to-date P&L statement when you complete your IRS-required Schedule C (Form 1040) as a self-employed ...
Do independent contractors have a profit and loss statement? ›
There are multiple benefits of having a profit and loss statement, even as an independent contractor, which includes the following: Tax reporting – As an independent contractor, you are considered self-employed.
How to show proof of income if self-employed? ›
Some ways to prove self-employment income include:
- Annual Tax Return (Form 1040) This is the most credible and straightforward way to demonstrate your income over the last year since it's an official legal document recognized by the IRS. ...
- 1099 Forms. ...
- Bank Statements. ...
- Profit/Loss Statements. ...
- Self-Employed Pay Stubs.
Profit or loss from business (sole proprietorship): Schedule C (Form 1040) The IRS requires sole proprietors to use Profit or Loss From Business (Sole Proprietorship) (Schedule C (Form 1040)), to report either income or loss from their businesses.
Can I do my own profit and loss statement? ›
If you use accounting software like QuickBooks, Peachtree or the like, the program will generate a P&L statement for you after you enter your sales and expense figures, but you can easily create your own using a basic spreadsheet and easy calculations, following the steps below.
Who needs a profit and loss statement? ›
Attract investors: New and existing investors will want to see periodic profit and loss statements to know how your company is performing financially. Prep for financing: If you apply for a business loan or want to finance new equipment, a bank will likely ask to review your profit and loss statement.
Can you 1099 someone you paid cash? ›
Cash payments of $600 or more to an independent contractor should be reported on a 1099 form, regardless of the payment method. Neglecting to issue the appropriate tax forms for cash payments can lead to tax implications and penalties.
What are the financial statements for self-employed people? ›
A self-employed profit and loss statement is a report that summarizes your business's revenues, expenses, gains, and losses over a given period. Also commonly referred to as an income statement, it's one of two essential financial statements for self-employed people, along with the balance sheet.
Who generates a profit and loss statement? ›
A profit and loss (P&L) statement is one of the three types of financial statements prepared by companies.
How to prove income if paid under the table? ›
10 Ways to Show Proof of Income If Paid in Cash
- Create A Paystub. One practical solution is to create your own paystub. ...
- Keep An Updated Spreadsheet. ...
- Bookkeeping Software. ...
- Always Deposit The Payment And Print Bank Records. ...
- Put It In Writing. ...
- Create Your Own Receipts. ...
- Utilize Your Tax Documents. ...
- Use An App.
To file your annual income tax return, you will need to use Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship), to report any income or loss from a business you operated or profession you practiced as a sole proprietor, or gig work performed.
How do I declare self-employment income? ›
Independent contractors generally report their income on Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship). Also file Schedule SE (Form 1040), Self-Employment Tax if your net earnings from self-employment are $400 or more.
How to fill out a profit and loss statement for self-employed? ›
Here's a general step-by-step guide to creating a profit and loss statement:
- Choose a reporting period. ...
- Gather financial statements and information. ...
- Add up revenue. ...
- List your COGS. ...
- Record your expenses. ...
- Figure your EBITDA. ...
- Calculate interest, taxes, depreciation, and amortization. ...
- Determine net income.
You need receipts for all expenses, regardless of amount, except expenditures that are less than $75 for1. · entertainment, · overnight travel, and.
What triggers an IRS audit? ›
The IRS receives copies of your W-2s and 1099s, and their systems automatically compare this data to the amounts you report on your tax return. A discrepancy, such as a 1099 that isn't reported on your return, could trigger further review.
Is a profit and loss statement a legal requirement? ›
By law, if your business is a limited company or a partnership whose members are limited companies, you must produce a profit and loss account for each financial year.
What do I need to file as self-employed? ›
Independent contractors generally report their income on Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship). Also file Schedule SE (Form 1040), Self-Employment Tax if your net earnings from self-employment are $400 or more.
Do small businesses need an income statement? ›
A small business owner, especially of a startup, will use quarterly—or even monthly—income statements to closely monitor the health of their fledgling enterprise. Having the most up-to-date information helps owners make informed, strategic decisions quickly and fix problems before they become expensive.
