Does your business make or lose money? Tracking your small business's financial progress by reviewing a profit and loss statement (P&L) will help you understand how your business is doing.
A P&L- the bottom line of small business accounting- enables you to determine whether your company is profitable and growing or is losing money and needs to make changes. Use this step-by-step guide to learn how to create your P&L statement and assess your company's financial health. Gain complete control over your business finances and aim for growth!
What is a profit and loss statement?
A profit and loss statement summarizes a company's income and expenses over a specific period. The profit and loss statement is also known as an income statement, a profit statement, a statement of operations, and a P&L report. The term used to describe this financial statement is a snapshot of a company's revenue and expenses over a specific time period.
Typically, profit and loss statements are prepared monthly, quarterly, or annual (quarterly and yearly reports are advisable). To prepare your profit and loss statement, you'll need to have in place the following financial documents:
Now, what are the steps to calculate your profit and loss statement? Let's follow them below.
How to create a profit and loss statement
The profit and loss statement is divided into two parts: the income earned during the period of the statement and the expenses incurred during the same period. To manually create a basic P&L, follow these steps:
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 your cost of goods sold (COGS)
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.
Expenses on Marketing
Business travel expenses
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.
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. 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.