The profit and loss statement is one of the most important financial statements for small businesses. Despite not being a legal requirement, it is a viable resource for improving transparency in business finances. It can assist SMEs in understanding their operating cash flow and the basis of it — business owners can figure out if their business is profitable and growing or if it is losing money and requires improvement.
Here, we’ll walk you through the profit and loss statement (P&L) for small businesses, how to analyze it, and share four profit and loss examples so you can better understand what a Profit and Loss statement is!
What Is a Profit and Loss Statement?
In terms of a business’s financial standing, a profit and loss statement also called a P&L statement or an income statement, helps you determine what your income and expenses are.
It shows you how much money has come into your business, where that revenue has gone, and what adjustments you need to make to increase profits.
Additionally, the P&L statement is crucial for proving the reliability of your business. It will help financial institutions, investors, bankers, and potential buyers determine your business’s financial standing and view your financial trends in the long run. Essentially, profit and loss statements demonstrate how well you identify complex business problems and what you did to solve them on a financial basis.
Profit and Loss statements are usually issued once a year or quarterly, depending on the company. As a general rule, the formula of the P&L statement looks like this:
Profit (net income) = Revenue (Income) – Expenses
In the P&L statement, expenses are subtracted from income to calculate profits and gauge the health of the company’s finances. P&Ls include the following categories:
- Revenue (or sales)
- Net income
- Interest expense
- Taxes
- (COGS) – Cost of goods sold
- Selling, general & administrative (SG&A) Expenses
- Marketing and advertising
- Technology/research & development
How To Analyze a Profit and Loss Statement
For any business, understanding and analyzing the profit and loss statement is pivotal. By analyzing your P&L statement in detail, you can identify strengths and weaknesses in your business. Your P&L statement will also make it easier for you to compare your company against similar companies and set industry benchmarks.
In general, you can analyze a P&L in two ways:
Horizontal analysis
An analysis of this type is commonly referred to as a series analysis. Specifically, it examines how a line item has changed over time. In addition, it enables you to see patterns, such as cyclical occurrences. Finally, you can take action when you detect red flags (e.g., high COGS).
Vertical analysis
In vertical analysis also called common-size analysis, the relative size of expenditure items is compared to the Company’s revenues. For example, how has a company’s marketing and research spending changed concerning its revenue?
Additionally, P&L statements can also be analyzed in many different ways, including…
- Analyzing your business’s growth trends and identifying profitable seasons.
- Identifying potential income-generating opportunities based on industry standards and competitors.
- Identifying areas where your business can be more efficient by studying margins (EBITDA margin, gross profit margin, net profit margin, operating margin).
- Understanding what generates the most income by looking at rates of return.
- Analyzing valuation factors (EV/EBITDA, P/E, P/B, etc.)
- Identifying improvement opportunities
When analyzing a P&L, you should also be aware of two important accounting principles.
- Profits are not the same as cash: A P&L statement does not equate directly to bank cash. The P&L report does not differentiate between transactions made on credit and those made on debit. It means that the transaction isn’t yet cash – instead, it’s receivables, which aren’t quite cash flows.
- Recognize the differences between accrual and cash accounting: A P&L statement provides a snapshot of how revenue and expenses relate. A cash basis accounting does not track revenues or expenses before cash transfers, whereas accrual accounting recognizes and records them as they arise.
Profit and Loss Example #1
Here is one of the profit and loss examples to help you understand.
The Music MM is an imaginary company that sells music merchantries and trains the trainees how to use musical instruments. After the end of the financial year, the Company prepares a Profit and Loss Statement for the entire year. In the financial year, the Company earned $30K by selling music merchandries and another $5K by charging for training. In total, $13,450 was spent by the Company on a variety of activities. In the process of selling an old machine, they gained $2,000 but lost $1,000 in settling a lawsuit with a consumer.
| Music MM
Profit and Loss Statement (Dec, 20XX)
|
||
| Revenues | ||
| Merchandise Sales | $30,000 | |
| Revenue from training | $5,000 | |
| Total Revenues | $35,000 | |
| Expenses | ||
| Cost of goods sold | $10,000 | |
| Rent | $2,000 | |
| Wages | $500 | |
| Interest Paid | $500 | |
| Transportation | $300 | |
| Utilities | $150 | |
| Total expenses | $13,450 | |
| Gains | ||
| Income from selling machine | $2000 | |
| Loses | ||
| Lawsuit | $1,000 | |
| Net Income (Revenue + Gains) – (Expenses + Losses) | $22,550 | |
It is one of the simplest examples of income statements, which calculates the net income by adding income values, expenses, gains, and losses. And it is called a Single-Step Profit and Loss Statement because it is derived from a simple calculation.
Profit and Loss Example #2
Lite Apparel is an imaginary company that manufactures and sells different clothing items. The company prepares a profit and loss statement every month, followed by one at the end of the financial year.
The company made revenue of $100,000 by selling garments in December – 20XX based on a COGS of $60,000. Moreover, the company makes $ 4,000 in interest income and $ 9,000 in revenue from selling scraps left over from making garments. The company accounts for expenses of $5,500 in rental costs, $15,000 in wages for factory workers, $7,700 in annual depreciation, and $ 9,000 on utility bills.
Depending on this information, following are company’s profit and loss examples for 31/12/XX.
| Lite Apparel
Profit and Loss Statement (Dec, 20XX)
|
||
| Revenues | ||
| Sales | $100,000 | |
| Scrap sales | $9,000 | |
| Interest Income | $4,000 | |
| Total Revenues | $113,000 | |
| Expenses | ||
| Cost of goods sold | $ 60,000 | |
| Rent | $ 5,500 | |
| Wages | $ 15,000 | |
| Depreciation | $ 7,700 | |
| Utilities | $ 9,000 | |
| Total expenses | $97,200 | |
| Net Income | $15,800 | |
So, according to financial reports for the month of December/XX, the Company generated a net profit of $ 15,800. In the above P&L statement, the expenses for the Company Lite Apparel are listed as major broad categories, with no further subdivisions of the categories into subcategories, based on the Single-Step Profit and Loss Statement approach. Due to the fact that further categorization is not required, it is simple and easy to make.
Profit and Loss Example #3
My Coffee is a coffee shop selling Coffee in the town. As part of its record-keeping, it prepares the shop’s income statement every year. The shop sold a total of 70,000 dollars on 31/12/XX, and 30,000 dollars were spent on the cost of goods sold.
According to the Company’s financial statements, rent was $6,000, utilities were $5,000, and one employee’s salary was $7,000. The shop’s Profit and Loss Statement for the year ended 31/12/XX is shown below.
|
My Coffee Profit and Loss Statement (Dec, 20XX)
|
||
| Revenues | ||
| Sales | $70,000 | |
| Total Revenues | $70,000 | |
| Expenses | ||
| Cost of goods sold | $30,000 | |
| Rent | $6,000 | |
| Wages | $7,000 | |
| Utilities | $5,000 | |
| Total expenses | $48,000 | |
| Net Income | $22,000 | |
The My Coffee shop generated a net income of $22,000 for the month.
All expenses in the above Profit and Loss Statement are listed in one category without further subdivision into subcategories in the Single-Step Profit and Loss Statement approach.
Profit and Loss Example #4
Company Sports Co. is a company that sells and manufactures sports equipment in the market. After the end of the financial year, the Company prepares a Profit and Loss Statement for the entire year. By selling its different types of equipment, the Company generated revenue of $1,000,000 for the year ending 31/12/XX.
During the year, the material used cost $ 600,000. In addition, over the course of the year, the Company incurred $60,000 in advertisement expenses, $80,000 in depreciation expenses, $15,000 in rent expenses, $5,000 in payroll taxes, salary expenses of $51,000, commissions on sales of $5,000, and $7,000 in operational expenses.
The Sports Co. company received 10,500 in credit for loans given to other parties and received $9,100 in payment for loans taken. For the year ended 31/12/XX, the Company’s Profit and Loss examples are as follows:
| Company Sports Co.
Profit and Loss Statement (Dec, 20XX)
|
||
| Sales | $1000,000 | |
| Cost of goods sold | $600,000 | |
| Gross Profit | $400,000 | |
| Operating Expenses | ||
| Advertisement expenses | $ 60,000 | |
| Depreciation expenses | $80,000 | |
| Rent charges | $15,000 | |
| Payroll taxes | $5,000 | |
| Salaries and wages | $ 51,000 | |
| Commission | $ 5,000 | |
| Other operating expenses | $ 7,000 | |
| Total operating expenses | $223,000 | |
| Operating Income | $177,000 | |
| Non-operating income | ||
| Revenues from Interest | $10,500 | |
| Interest expenses | $9,100 | |
| Total non-operating income | $1,400 | |
| Net Income | $178,400 | |
Therefore, the company earned $178,400 in net income during the year ended 31/12/XX. According to the P&L Statement shown above for the Company Sports Co., the different expenses are divided into the categories that seem relevant to their function according to the multistep P&L statement approach.
In contrast to the single-step approach, this P&L statement version requires more time and effort since all expenses must fall into their specific line item categories. However, this allows the company’s management and its stakeholders to evaluate the company’s performance in a more thorough manner, which enables a more in-depth analysis of each expense category.
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Conclusion
Small businesses need to create a profit and loss statement because it is one of the best indicators of a company’s profitability. Whether you are looking to become profitable or are planning a large acquisition, it is always a good idea to generate regular profit and loss statements. This will allow you to grow more effectively in the future!
