A profit & loss (P&L) is one of the three fundamental financial documents. In the simplest terms, how much money your business makes is the difference between how much money you bring in and how much you spend. If income exceeds expenses, you’re making a profit. If not, you’ve got a loss on your hands. A profit and loss (P&L) statement will put all the numbers in one place so you know where you stand and can make any adjustments that are necessary to bring up your income or tone down expenses. P&L statements can be done for any given period of time, but it’s helpful to review your P&L monthly or at least quarterly.
How to Create a P&L 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.
Step 1 – Track Your Revenue
Revenue is the money you have received in payment for your products and/or services. As you are paid, enter and keep track of the figures. This will be your total operating revenue.
Step 2 – Determine the Cost of Sales
These are not your day-to-day fixed expenses (like rent, salaries, etc.), but rather the expenses that vary depending on how much business you’re doing. You might also see this referred to as the cost of goods sold.
These variable costs might include inventory, raw manufacturing materials, and additional staff you hired to cover a busy period. (Regular salaries are fixed expenses and will be figured in later.)
Step 3 – Figure Out Your Gross Profit
Deduct the cost of sales (those variable operating expenses) from your total revenue to find out the gross profit of your operations for that particular time period.
Step 4 – Add Up Your Overhead
These are the fixed expenses you have to run the business. They don’t vary much from month to month or rise and fall with the number of sales you make. Examples include expenses like rent, staff, advertising, equipment leases, and phones. If you have costs you pay yearly, like insurance, divide them by twelve to get your monthly expense.
Step 5 – Calculate Your Operating Income
Deduct the cost of overhead from your gross profit. The result is your operating income.
Step 6 – Adjust for Other Income and/or Expenses
This would be money coming in or going out that isn’t related to the actual operation of the business. This type of income would include things such as interest or dividends from company investments, and expenses would be items like finance charges and interest paid on loans.
Add or subtract these from your operating income, and you are left with your total pre-tax income, or your net profit.
Step 7 – Net Profit: The Bottom Line
This is really the most important number of all, and the main reason for figuring out all the line items above. This number will show if you have a profit or loss after paying all your expenses.
One Additional Factor – Tax Payments
How income tax is shown on your profit and loss statement will depend on the legal structure of your business. We’ve left this out of the calculations above because typically, sole proprietorships, partnerships, LLCs and S corporations don’t include them here because their taxes are paid as part of their individual income taxes. If you have a C corporation, you would deduct your tax payments from the pre-tax income figured out in step 6 to determine your net income.
What to Do With Your P&L
Using this general profit and loss format, you’ll not only gain an understanding of the current financial health of your business, but you can also make budgets and projections for the future. Remember to always be conservative when estimating income so you don’t plan expenditures you won’t be able to afford.
You can also use the P&L to figure out your gross profit margin, which is the difference between the costs of producing a product or providing a service and how much you’re selling it for. In other words, how profitable your products and services are.
To figure out your profit margin, using the figures you compiled above, divide your estimated average monthly gross profit by your estimated average monthly sales. For example, if your monthly gross profit is $5,000 and your monthly sales are $10,000, your profit margin would be 50% (remember this is gross profit, before deducting overhead costs).
Now that you know that, what do you do with the info? Keeping track of your profitability will let you keep your pricing and costs in line. If your profit margin starts decreasing, that likely means your costs have gone up, which is a signal for you to find new suppliers or raise your prices.
Average profit margins vary by industry, but knowing yours can go a long way toward making and keeping your business profitable.
