How to create a profit and loss statement for small businesses

17
March 2022

A successful business generates profits: the more, the better. Profit and loss (P&L) statements are financial statements that summarize the revenues, costs, and expenses incurred during a specific period, typically a quarter or fiscal year.

Use this step-by-step guide and learn how to use your P&L statements to assess your company's financial health. Gain complete control over your business finances and aim for growth!

How does a profit and loss statement works?

Your P&L provides information about your company's ability or inability to generate profit by increasing revenue, reducing costs, or both. You can use a profit and loss statement to help develop new sales objectives and, most importantly, a reasonable price for your goods or services. Every public company issues on a quarterly and annual basis the following three financial statements:

  • Balance sheet.

  • Cash Flow Statement.

  • Profit and Loss Statement. Also known as an Income Statement.

P&L management is the process by which a company manages its profit and loss statement through revenue and cost management.

How to calculate your profit & loss statement

A P&L statement is not just something that only large corporations have to worry about; it's an essential part of any business plan and a great way to gauge how your business is doing. To prepare your profit and loss statement, you'll need to have in place the following financial documents:

  • Banking transactions.

  • Cash transactions.

  • Income listings.

Now, what are the steps to calculate your profit and loss statement? Let's follow them below:

1. Calculate your business revenue

Revenue is the money you receive for your goods and services. Revenue is sometimes referred to as the top line because it appears first on a company's income statement.

To calculate your business revenue, use the following formula:

  • The number of units sold x average price.

  • Number of customers x average price per unit provided.

2. Calculate the costs of your sales

Your sales costs vary according to how much business you do; you may also refer to them as the cost of goods sold. Inventory, raw manufacturing materials, and additional staff hired to cover a busy period are variable costs; regular salaries are fixed expenses (will be calculated later).

3. Determine your gross profit

To calculate your gross profit, you need to deduct costs from your revenue by using the following formula:

Gross Profit = Revenue - Cost of Goods Sold

Once you do the math, you'll figure out how much money you need to cover business expenses after paying for your products or services.

You can also calculate your gross margin percentage by dividing your gross margin by your revenue. See the formula below:

Gross Margin / Revenue = Gross Margin %

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

Now, let's apply the Gross Profit Formula to solve a hypothetical case:

You purchased 100 bicycles from a supplier at the cost of $100 each: you incurred direct costs of $10,000. You sold them for $395 per piece, yielding a revenue of $39,500. Your gross profit would be $29,500. Your gross margin percentage would be 75%.

4. Calculate your operating expenses

Operating expenses or operating costs are expenses associated with day-to-day business activities. Operating expenses could include the following:

  • Your office or store rent

  • Utilities: internet, electricity, water, and gas.

  • Payroll

  • Expenses on Marketing

  • Business travel expenses

  • Office Supplies

  • Insurance

You shouldn't include taxes or any interest on loans in this category, meaning you should distinguish it from the costs of your goods and services.

5. Evaluate your operating income

Once you get a hold of your operating expenses and gross profits, it's time to do the math and get your Operating income. Subtract your overhead costs from your gross profit. Your operating income is the result.

Gross Profit - Operating Expenses = Operating Profit/Loss 

Your operating income is an indirect measure of productivity and a company's ability to generate more earnings, which can then be used to expand the business further. Investors closely monitor operating profit to assess a company's efficiency trend over time.

6. Adjust for other income and expenses

Include your EBITDA or earnings before interest, taxes, depreciation, and amortization, which are funds coming in or going out that are not directly related to the operation of the business. The most common method for calculating EBITDA is to begin with operating profit, also known as earnings before interest and tax (EBIT), and then add depreciation and amortization.

There are two EBITDA formulas: One based on net income and one on operating income. The following are the EBITDA formulas:

EBITDA is calculated as Net Income + Taxes + Interest Expense + Depreciation and Amortization.

and

EBITDA = Operating Income + Depreciation and Amortization.

7. Net profit or loss

Your net profit is your bottom-line number and what remains of your business revenue after subtracting all your expenses and costs; see the formula below:

Net Profit/Loss = EBIDTA - (Interest + Taxes + Depreciation)

Hopefully, your profit indicates that your business is healthy, but it can also indicate impending business profitability problems or losses. You can go one step further and calculate your net profit percentage by dividing your net income by net revenue and multiplying your result by 100. 

It sounds like much work, but you can get free profit and loss templates here.

A note on the profit and loss statement

Your company's legal structure determines how income tax is shown on your profit and loss statement. We've left this out of the calculations because sole proprietorships, partnerships, LLCs, and S corporations typically don't include it because their taxes are paid as part of their owner income taxes. If you have a C corporation, deduct your tax payments from the pre-tax income calculated in step six to calculate your net income.

It's critical to create a profit and loss statement for your small business because it's one of the most valuable reports for determining whether or not your company is profitable.

A profit and loss statement, which funding institutions and investors require, can help you identify areas of success and where your small business may need support.

Disclaimer: The content of this post has been prepared for informational purposes only. It is not intended to provide and should not be relied on for tax, legal, or accounting advice. Consult with your tax, legal, and accounting advisor before engaging in any transaction.