The profit and loss statement is a financial statement summarizing a business’s total income and expenses over a specific period — usually a fiscal quarter or year. The P & L statement is also known as an income statement. Looking at a P & L statement for the first time can be daunting. As a manager or business owner, though, the ability to read and interpret the statement is essential to making informed business decisions and preparing a business tax return.
What does a P & L statement show?
Unlike a balance sheet, which shows your business’s assets and debt at a single moment in time, the profit and loss statement shows your business’s financial performance over a period of time. “It begins with an entry for revenue, known as the top line,” explains financial analyst Jason Fernando. After the top line, the statement lists operating expenses such cost of goods sold and costs of doing business. “The difference, known as the bottom line, is net income,” Fernando says.
P & L statements are often used to compare a business’s financial performance across two different time periods. For example, it may have a column for the current fiscal year and one for the previous year. This makes it easier for you to see how revenue and expenses are evolving and to identify areas for potential change in the future.
When should you prepare a P & L statement?
According to Fernando, all publicly traded companies are “required to prepare profit and loss statements and must file their financial statements with the SEC so that they can be scrutinized by investors, analysts, and regulators.” Though small, private companies may be legally exempt from preparing formal financial statements, doing so is nonetheless advisable if only because preparing a P & L statement can grant owners valuable insight into the state of their business.
Additionally, investors and analysts can use P & L statements to assess the profitability of a business. You’ll need to prepare such a statement if you are hoping to convince an investor to lend you money. P & L statements are also a valuable tool when preparing business taxes.
Finally, businesses that are just starting up are required to create a P & L statement. “This statement is created pro forma, meaning that it is projected into the future,” writes Jean Murray, an expert on business law. “Your business will also need a pro forma P & L when applying for funding for any new business project.”
P & L statements are typically prepared quarterly as well as yearly, but depending on your business operations, you may need to prepare them more frequently — on a monthly or even weekly basis.
How do you prepare a P & L statement?
Preparing a profit and loss statement can be a major endeavor if you run a large business. Information necessary to create a P & L statement includes detailed transaction and income listings, invoices, receipts, and information about discounts or returns. “Don't forget to add cash transactions, both income and expenses,” Murray warns. “Even if you have business accounting software, you may still have to enter cash transactions manually, including cash for petty cash and income.” For pro forma statements, you’ll need to make projections instead.
Owners of small businesses may find it feasible to prepare P & L statements using only specialized software. However, as the business grows in complexity, it’s generally better to hire a professional accountant or even an accounting team to handle this task. This will help ensure the statement is accurate and give you more time to devote to assessing and improving your business.
If you’re still not sure about P & L statements, consider contacting a business or financial advisor to help you create this essential document.