What is a profit and loss statement, and how to create one?

Are you looking for ways to better manage your income and expenses and get a clear understanding of your company's financial performance? Then it’s time to create a profit and loss (P&L) statement.

A profit and loss statement can provide you with a snapshot of the financial health of your business, helping you make informed decisions about managing your money, cutting costs, and growing your business.

Here, we’ll cover important details you should know about profit and loss statements. Plus, we'll walk through creating your own P&L statement.

What is a profit and loss report, and how often do you need to do a P&L statement?

Also known as a profit and loss statement, a profit and loss report is a document that summarizes your company's financial performance over a specific period. It is vital to see what money is coming in and going out, so you have a clearer picture of the health of your business.

Different businesses will need to run a profit and loss statement at different cadences depending on the size and nature of the business. A small to medium-sized business will generally want to run a P&L statement more frequently, perhaps monthly, to see how significantly their revenue fluctuates from day to day and week to week.

A larger business may be content running a profit and loss report quarterly if their revenue fluctuates less frequently. This may give them a broader view of their finances, especially if they don’t need to have such a laser-focus on smaller financial shifts.

Generally, most businesses will also perform an annual profit and loss statement to assist with their year-end financial reporting.

A profit and loss statement lets you focus on how much money your business earned (revenue), how much it spent on items like supplies, rent, and employee wages (expenses), and the overall profit (net profit).

The profit and loss formula is simple:

Revenue – Expenses = Net Profit (or Loss).

Benefits of preparing a profit and loss statement for a small business

A profit and loss statement can be a valuable tool for any business owner. It provides insights into your company’s financial health, helps you make informed decisions, and tracks progress toward goals.

Your profit and loss report is a great way to help you forecast revenue. Revenue forecasting is when you figure out when money is coming in and when it’s going out, so you can make better decisions about when and how to use your cash flow in a coming time period.

Think of your P&L statement as a financial report card that can help streamline your financial data and show you how well your business is doing.

Here are some of the advantages of a profit and loss statement:

• Provides a quick look at your finances. A P&L statement is a snapshot of how much money you've made, how much you've spent, and your net profit.

• Helps you make informed decisions to grow your business. You can see which products or services generate the most revenue, which expenses are the highest, and which areas need improvement. This can help you identify areas where you need to cut costs or invest more resources and make strategic decisions about how to grow your business.

• Identifies cash flow issues. A P&L statement can help identify cash flow issues before they become a major problem.

• Tracks progress toward goals. Compare your financial performance to past periods or industry standards to see how you're doing.

• Assists with financial planning. It can provide insights into potential revenue and expenses, helping you create a realistic budget and forecast for the coming months or years.

• Helps with tax prep. This summary of your company’s revenue and expenses can help relieve some stress during tax time.

• Simplifies financial reporting. It provides a clear and concise summary of your company’s financial performance, making it easier to communicate with investors, lenders, and other stakeholders.

• Attracts investors and lenders. Stakeholders want to see that your business is profitable and financially stable before they invest in you.

Key components of a profit and loss statement

Small business financial statements like a P&L report can look a little different depending on the industry you’re in.

For instance, a P&L statement for a service-based company like a tutoring business or a graphic design firm might look different compared to a product-driven business like a clothing brand or a manufacturer. This will show up in your cost of goods sold entry (COGS) because it’s a matter of whether you had to spend money to create a product or if your cost was in what it took for you to provide a service.

However, the main components of a P&L statement generally apply to all businesses. Here’s what you can expect to see in your statement:

• Revenue

• Cost of goods sold (COGS)

• Gross profit

• Operating expenses

• Operating income

• Other income and expenses

• Net profit

Revenue

Your revenue represents the total amount of money your business earns during the specified period. It will include sales, fees, commissions, and any other income generated by the business.

Cost of goods sold (COGS)

The cost of goods sold, or COGS, is the direct cost of producing or acquiring the products or services, including material and labor expenses. It is how much it costs you to produce and sell your product over a certain amount of time. It does not include indirect costs like overhead.

Gross profit

Gross profit is the difference between revenue and COGS. It represents the amount of money a business has left after deducting the direct costs. Bear in mind, this amount will still be subject to more expenses to come.

Operating expenses

Operating expenses or “OpEx” are the expenses you face while trying to run your business. These are the indirect costs of running a business, overhead such as rent, salaries, utilities, insurance, marketing expenses, and depreciation.

Operating income

Your operating income is the profit your company generates from its normal business operations, before deducting interest and taxes.

Other income and expenses

Other income and expenses are even more non-operating items that are not directly related to the core business activities of a company. They may include interest income, interest expense, gains or losses from the sale of assets, and other one-time or non-recurring windfalls or fees.

Net profit

Net profit is the final profit or loss earned by a business during the specified period after subtracting all expenses. This is how much you are actually ahead.

Types of profit and loss statements

A business can use several types of profit and loss statements, depending on its needs and goals. Here are a few of the most common profit and loss statement examples:

Single-step profit and loss statement

The single-step profit and loss statement is one of the simplest types of P&L reports, it lists all revenue in one section and all expenses in another. This is a good option for small businesses that don’t need to account for many revenue streams or expenses.

Multi-step profit and loss statement

The multi-step profit and loss statement is more detailed than the single-step statement. It breaks down the revenue and expense categories into multiple sections to provide more detailed insight.

Comparative profit and loss statement

The comparative profit and loss statement is labeled so because it literally compares the company's financial performance over two or more periods. These could be monthly, quarterly, or annually.

Projected profit and loss statement

Finally, the projected profit and loss statement estimates the company's financial performance for a future period, perhaps next quarter or next year.

How to prepare a profit and loss statement

There are two main ways to prepare a profit and loss statement:

Cash method

Cash basis accounting records revenue and expenses when cash is received or paid out. That means revenue is recognized when the customer pays for the product or service, and expenses are recognized when the business pays for them. If you buy something on credit for the business in December, but then pay it off in January, the expense is marked in January. It’s all about when the cash comes in or goes out.

Accrual method

Accrual basis accounting records revenue and expenses when they are earned or incurred, regardless of when cash is received or paid out. For example, if a company delivers a product to a customer on credit, the revenue would be recognized at delivery, even if the customer doesn't pay until a later date. This method is typically used by large businesses.

The key difference is the cash method recognizes revenue and expenses when the actual cash is received or paid out, while the accrual method recognizes revenue and expenses at the point of the transaction.

For example, say a business bills $10,000 to a customer in December, but the customer doesn't pay until January. Under the cash method, the revenue would be recognized in January when the cash is received. Under the accrual method, the revenue would be recognized in December when the services were provided.

Learn more about the differences between cash basis and accrual basis accounting.

How to create a profit and loss statement?

Now that you understand the ins and outs of a P&L statement, it’s time to create your own.

Once you’ve gathered and organized all your financial documents, follow these steps to prepare a profit and loss statement:

• Step 1: Add up your sales numbers to determine your company’s total revenue.

• Step 2: Make a list of all operating expenses incurred during the specified period. Be sure to categorize each expense to make it easier to organize and analyze.

• Step 3: Calculate the cost of goods sold (if applicable). If your business sells products, calculate the cost of goods sold (COGS) by adding up the cost of materials, labor, and other expenses related to producing or acquiring the products sold during the period.

• Step 4: Determine the gross profit by subtracting the COGS from the total revenue.

• Step 5: Deduct all operating expenses, such as rent, utilities, salaries, and marketing expenses, from the gross profit to calculate the operating profit.

• Step 6: Add or subtract any non-operating income and expenses (i.e., interest income or expenses, gains or losses from the sale of assets, or one-time expenses) to calculate your net income.

Profit & Loss statements are only one component of running an efficient business. PayPal offers a slate of invoicing and payments tools to help your business run smoothly.