Most business owners have heard the term “profit and loss statement.” If you’re new to the world of business finance, you might be wondering exactly what it is and how to prepare one.
This crucial document is an important part of your financial reporting processes. It becomes especially important during tax season when you’re reporting your business income to the IRS. Here are the basics of profit and loss statements every business owner should understand.
What is a profit and loss statement?
A profit and loss (P&L) statement, also known as an income statement or earnings statement, is exactly what it sounds like: a document that identifies a business’s profit (revenue) and losses (expenses). These statements help you evaluate your company’s financial health, typically quarter by quarter.
According to QuickBooks, a P&L statement summarizes your company’s profitability for that given time period. If there are any drastic losses, you can then find ways to compensate by increasing revenues or cutting costs.
P&L statements are often part of a company’s overall financial accounting report, along with the balance sheet, the stockholders’ equity statement and the cash flow statement.
In addition to sharing a P&L statement with your tax preparer, you may also need to share this document with any lenders when applying for funding.
When would I need to prepare a profit and loss statement?
While it’s advisable to review your P&L statement each month or quarter, you should at least do so annually before you file your business tax return. The IRS needs a record of your business’s revenue and expenses to determine your total taxable business income (essentially, sales minus expenditures equals profit). If you are having your business taxes professionally prepared, you will need to provide the preparer with your P&L statement.
In addition to sharing a P&L statement with your tax preparer, you may also need to share this document with any lenders when applying for funding.
What information do I need to include on a profit and loss statement?
There are various components that make up a profit and loss statement. Fundera outlined common items included in the document:
- Revenue: total sales, money received from selling property or equipment, and refunds
- Expenditures: total expenses
- Cost of goods sold (COGS): cost of materials and time to make products
- Gross margin: revenue minus COGS
- Operational expenditures (OPEX): cost of running business, including travel, rent, equipment, workers’ wages
- Earnings before interest, tax, depreciation and amortization (EBITDA): includes non-cash items and helps measure profitability
- Depreciation: loss of value over time, like that of machinery or equipment
- Earnings before tax (EBT): revenue minus COGS, OPEX, interest and depreciation and amortization
- Profit: revenue minus all your expenses
How to create a profit and loss statement
You can use free templates to get your statement started, like one of these from Microsoft Office or Corporate Finance Institute; or, you can invest in accounting software to manage it for you.
If you choose to do the former, follow these steps along with the template of your choice:
- Begin calculating your business’s revenue by quarter
- Subtract your expenses from your revenue by quarter (to calculate your EBITDA)
- Factor in taxes, interests, amortization and depreciation, and subtract from EBITDA
- Identify profit or loss
If the statement concludes that there is a loss, you can find ways to compensate and work to turn that loss into a profit. By reviewing your P&L statement regularly, you will avoid any major losses and will give yourself ample time to recover if needed.
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