What Is a Profit and Loss Statement? A Complete Breakdown

As someone in charge of a business, you have to be on top of your cash flow. This will help you know if what you put together is bringing you any money. That’s why you need this profit and loss statement.

It puts together the numbers and lets you see clearly what your company earned and what you spent money on. In essence, this report informs whether the organization was in financial profit or in a deficit. Financial data should underlie all decisions and strategies.

You can manage anything from a boutique to a multinational firm. Still, the P&L statement will be a part of your business. Today, we'll talk about “What is a profit and loss statement?” and everything else to know. This includes a profit and loss statement example to help you better grasp the term.

What Is a Profit and Loss Statement?

A company’s profit and loss statement presents the financial outcomes in a summary form. It gives a view of the earnings, costs, and expenses throughout the period. You may follow it over the course of time, like a month, quarter, or one fiscal year.

The other common name of this financial piece of paper is an income statement. Others call it a statement of operations. It will give some insight into how the company earns money. On the other hand, you’ll see the way it spends its money and any profit that it makes.

The formula says you subtract total expenses from revenue. With this, you arrive at what is called a net profit or a net loss.

You may think that this is too simple, so it doesn’t mean much. However, the details within each area provide a detailed look at a business’s finances. P&L statements do not only tell whether a business is profitable. It also tells where it earns its profit and where its costs lie.

Components of a Profit and Loss Statement

To make a P&L statement, there are some essential parts that you put together:

Revenue

Revenue, which is majorly referred to as the “top line,” represents the total income your business would have made. This is where you begin, before the deduction of expenses. That can include earnings from the sale of products or services or rental properties. It can also include any interest and money that comes in from other places.

When your business derives revenue from a variety of sources, income details can be partitioned. This ensures that you can measure your performance in each particular area.

Cost of Goods Sold (COGS)

COGS means all the money you’ll use to produce those goods that the company will sell. These are fundamental costs in the calculation of how profitably your business can generate revenue. Such costs might include the price of raw materials or the wages of labor engaged in production.

For businesses that offer services, the COGS is usually known as the “Cost of Services”. Such expenses usually entail payments to contractors as well as other such costs.

Gross Profit

In order to calculate gross profit, you have to deduct the cost of goods sold from total revenues. To compute Gross Profit, you just subtract COGS from Revenue. This indicator is the amount of earnings that a business would make. That's after deducting every direct expense incurred in the firm’s production process.

Gross profit is an important tool for knowing the efficiency with which a firm uses resources.

Operating Expenses

When you’re managing a business, there’s a lot of money that goes into doing that. You need to have a proper number for what goes into that, too. It’s what comes under the umbrella of operating expenses. They have nothing to do with production or service delivery.

We’re talking about the money you spent on maybe rent or utilities. It will also factor in marketing, advertising, office costs, any legal bills, and maintenance. These costs underpin the primary role of the business on a daily basis. However, they are not part of the chain that creates goods or services.

Operating Profit

Operating profit is also called operating income. To get this, your operating expenses have been taken out of your gross income. The operating profit figure indicates the amount gained by a company from its key business. That's before the interest and tax expense have been removed.

Non-Operating Items

Such items involve revenues and expenses that are not generated from the normal business activities. For example, interest received or paid, or gains or losses from securities. You may also incur irregular costs or profits and tax obligations as part of this. Such income and expenditures are factored in when computing net profit or loss. However, they are excluded from the company's day-to-day business.

Net Profit/Loss

The bottom line becomes the last determinant. This is what you come across at the end of the P&L statement. It is the money you’ve made or lost for that period you calculated for. It is the end result of a company’s performance in terms of its finances. That’s after you’ve finally removed all the expenses. It shows whether the company is running at a profit at the time. 

Types of P&L Statements

Companies use formats of profit and loss statements according to what they need and their accounting systems:

1. Single-Step P&L Statement

Under a one-step P&L statement, revenues and gains are summed first. Then, the expenses and losses add up later. Because of its not very complex structure, the single-step approach is popular. This is mainly among small businesses and individual entrepreneurs.

The simplest formula used is as follows. To come up with Net Income, you add revenues and gains and subtract expenses and losses. This approach does not distinguish operating from non-operating activities. It provides an easily understandable picture of the company’s total profitability.

2. Multi-Step P&L Statement

This is the one that separates operating activities and non-operating activities. A multi-step statement provides a better overview of an entity’s income statement. By dismembering the P&L statement into a number of stages, the users will be able to see the details. Items like gross, operating, and income before taxes. These will tell the performance of the company at important points in its operations.

This is a preferred format by most large enterprises and all publicly quoted companies. That's because it enhances the clarity of the sources of profit.

3. Cash vs. Accrual Method

Also, profit and loss statements are sometimes categorized with the methods that are used. Income is accounted for in the case of receipt of cash using the cash method. Then, when payment is made for expenses. For small firms and individual finances, the cash method is broadly practiced because of its ease.

Under the accrual method, recorded income is at the time it is earned, regardless of payment. The recorded expenses are at the time of incurring them rather than the time of payment. The accrual method provides a better picture of the financial state of a company. 

Profit and Loss Statement Example

Now, let's demonstrate a profit and loss statement example to see how it works in a real-life situation. We'll assume a simple case of a retail business that operates for only a month:

The cumulative revenue of the retail shop was $55,000. This consists of $50,000 on the sale of products and $5,000 from services. 

Goods sold cost equivalent to $30,000. This was gotten by calculating the inventory, which began at $20,000 and the purchases at $25,000. Then, they deducted the ending inventory of $15,000. The gross profit, hence, was $25,000. So, that's a 45% margin.

Total operating expenditures for the retail shop were $18,000. This included $10,000 for employee salaries. Then, there was $3,000 for rent and $1,200 for electricity and other utilities. $2,500 was spent on marketing, $800 on insurance, and $500 on office supplies. After taking out operating expenses, the business made an operating profit of $7,000, with a 12.7% margin.

Other expenses were recorded at $1,000 in interest owed and $1,500 in taxes. The net income, after this deduction, amounts to $4500. In the end, they had an 8.2% margin on total revenue.

Bottom Line

It's safe to say you now know “What is a profit and loss statement?”. This document may be required by law for some. Regardless, it is an important insight into your business’s financial dynamics and results. So, always take time to work on it and review it. Also, use a good profit and loss statement example as a guide. Your business will be all the better for it.

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