The Profit & Loss Statement
The profit and loss statement, also known as the income statement, is one of the three main financial statements your company should prepare quarterly and annually in addition to the balance sheet and cash flow statement.
At a glance, the P&L shows your company’s ability to generate profit during a specified fiscal period. The P&L summarizes revenues, costs, and expenses for that period to arrive at net income. Net income can also be referred to as the bottom line, earnings, or profit. If this number is negative, it would be referred to as a loss.
For your business purposes, the P&L has three main uses. The first is as one of the three required financial statements. Second, it provides a vehicle for internal analysis of your company’s operations. We will discuss that below with a few helpful ratios. Lastly, it is used during tax preparation by summarizing the revenue and expenses to be reported on your annual tax return.
Quick Tip: Calculate ratios & margins to get to an apples to apples comparison
Revenue – Expenditures = Profit
The equation is simple but unfortunately there is just a little bit more to it than that. But don’t worry – no advanced math is required!
- Start with your revenues. This is any income during the specified period.
- Then determine your Cost of Goods Sold (COGS). COGS includes all costs directly involved in selling a product or delivering a service. This could include labor and parts in a manufacturing business, fresh produce for a restaurant, or sales commissions in a service company. COGS can also be referred to as the cost of sales.
- Next deduct operating expenditures or OPEX. OPEX refers to expenses to run your business – meals & entertainment, travel, salaries, insurance, advertising, maintenance, services, office supplies, etc.
- Finally, deduct depreciation, or the amount allocated each period to record the loss in value of your fixed assets like equipment and computers.
Now, you’re ready for your calculation:
Revenue – COGS – OPEX – Depreciation = Net Profit
Some helpful ways to analyze the P&L Statement
One way to find insights in the P&L is by calculating margins. Common calculations are gross profit margin, operating profit margin, and net profit margin.
1. Gross Profit Margin
2. Operating Profit Margin
3. Net Profit Margin
Other things to look at in your P&L
Are your numbers fluctuating based on season? For example, if you sell a summer-focused product or service, does it match the cycle of weather? If not, something may be wrong.
The COGS or Cost of Sales should increase if revenues increase and decrease if revenues decrease. If your COGS number is going up while revenues are decreasing you will want to examine your product/service related direct costs closely.
Always look at your P&L alongside the balance sheet & cash flow statement
Without comparing the P&L to other financial statements (the balance sheet & the statement of cash flows) it is hard to see the full picture of your business.
As you continue to operate your business, keep these ratios and tips in your analysis toolbox so you can maintain control of your profitability.