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Knowing how to read a profit and loss statement doesn’t require an accounting degree. And it’s worth figuring out how to do it. A profit and loss statement shows your business’s financial health. Read on to learn what a P&L statement is, what you can learn from it, and how to create one.
Key Points
• P&L means profit and loss statement, which is a key financial statement that tracks how money moves through a company over a period of time, showing funds received, expenses paid, and remaining profit.
• P&L statements generally include revenue, cost of goods sold, gross profit, operating expenses, operating profit, other income and expenses, and net profit.
• Most P&L statements use the accrual accounting method, which records revenue as it is earned and accounts for money expected in the future.
• Business owners use P&L statements to spot performance trends, evaluate the impact of changes, decide where to shift resources, and determine whether funding is needed.
• Lenders and potential investors typically request P&L statements to evaluate a company’s financial health and its likelihood of repaying loans or generating returns.
What Is a P&L?
In business, P&L is another way of saying profit and loss statement. A profit and loss statement shows how money moved through a company over a period of time. It includes what funds came in, what went out, and what remains as profit.
A profit and loss statement is also called an income statement.
P&L Formula
A P&L encompasses a lot of information. But here is the basic overarching formula used in a P&L:
Revenue – Expenses = Net Profit (or Loss)
Key Components of a P&L Statement
Though they can vary by industry, P&L statements generally include several key components. These include revenue, cost of goods sold (COGS), gross profit, operating expenses, operating profit, other income and expenses, and net profit.
• Revenue is the top line of the P&L statement. It includes the income that the business generated from selling goods or services in the period.
• COGS is all of the direct costs tied to producing what you sold. This could be raw materials, production labor, contractor fees, and/or direct service delivery costs.
• Gross profit is revenue minus COGS. Gross profit shows what’s left after covering the direct costs of production but before accounting for overhead.
• Operating expenses are the everyday costs of running the business that aren’t tied directly to production. This includes things like rent, utilities, and salaries for administrative staff.
• Operating profit is gross profit minus operating expenses. Operating profit shows how profitable the company’s core operations are before including taxes or financing.
• Other income and expenses are included in the P&L statement in order to account for things like interest income, loan interest, one-time gains or losses, and unusual costs.
• Net profit, or net income, is the “bottom line.” This is the profit left over or loss incurred. A positive net profit means the business earned more than it spent, and a negative net profit means it spent more than it earned.
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How to Read a P&L Statement
To read a P&L statement, start from the top with the revenue and then move down the page. You can subtract the cost of goods sold to find gross profit. Then you can deduct operating expenses from gross profit to get operating income. And finally, you can subtract non-operating expenses (including taxes and interest) from operating income to reach net income, your true bottom line.
How to Create a P&L Statement
To create a P&L statement, you’ll need to calculate the metrics listed in the previous section.
P&L statements can be created using one of two accounting methods: the accrual method or the cash method. Most often they use the accrual method of accounting, but some small businesses use cash accounting.
The accrual accounting method records revenue as it’s earned. This method accounts for money that the business expects to receive in the future.
The cash method is a more simple system that only accounts for cash received or paid. Revenue is recorded when cash is received, and expenses are recorded when cash is paid.
Why the P&L Matters for Your Business
What is a P&L’s role in business? Many small companies are not required to create a P&L. However, a P&L statement can be useful to your business in a number of ways.
First, the P&L can help you evaluate your business’s financial performance. At the most basic level, you can see easily whether it’s making a profit or not. You can also compare your P&L with P&L statements from similar companies.
A P&L statement can also help you spot performance trends. For example, if your revenue is increasing but your profits are decreasing, it can be a warning that your costs are outpacing your sales. This could be due to payroll growing too quickly, suppliers raising prices, or high overhead. In addition, if you’re making changes to your business, you can compare P&L statements from before and after you implement them to evaluate what kind of impact they may have had.
Your P&L can also help you decide what should come next for your business. It shows where your company is gaining ground, where it’s losing traction, and where resources need to shift. It could also show you if you need to apply for funding, like a small business loan.
Additionally, if you do apply for a loan, whether it’s a term loan, a small business line of credit, or some other form of funding, the lender will likely want to see your P&L statements. This will help them evaluate how likely your company is to be able to repay the loan. Potential investors will also likely want to see your P&Ls to help them evaluate your company.
The P&L statement may also be necessary if your business has a board or management team that sets explicit P&L targets, like cutting operating expenses by a set percentage, growing revenue faster than costs, or improving net margins.
Finally, though the Internal Revenue Service (IRS) does not usually require P&L statements (except possibly for audits), much of the information on the P&L is required on its tax forms.
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P&L vs Balance Sheet vs Cash Flow Statement
Profit and loss statements track revenue, expenses, and profit across a period of time. They show whether the business earned more than it spent.
Balance sheets are a snapshot of assets, liabilities, and equity at a single point in time. They show what the business owns, owes, and has invested.
Cash flow statements show cash flow, the actual movement of money and clarify whether operations, investments, and financing are generating or consuming cash.
Each kind of statement serves its own purpose, though they all describe elements of a firm’s financial activity. Looking at all three can provide a full view of the company’s finances.
The Takeaway
What is a P&L in business? A P&L statement is an invaluable tool to help you understand how well your business is doing and make decisions about where to take it next. It’s also an important asset when you’re trying to attract investors or take out funding to help your business grow.
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FAQ
What does P&L mean in business?
P&L stands for profit and loss. It also refers to the financial statement that shows a company’s revenues, expenses, and net profit or loss over a specific period of time.
How often should a small business prepare a P&L statement?
Depending on how they’re using them, businesses may prepare P&L statements monthly, quarterly, or annually.
What is the difference between gross profit and net profit?
Gross profit is the amount of money a company earns from selling its goods or services, after subtracting the cost of goods sold (COGS). Net profit is the actual profit a company keeps after deducting all expenses from total revenue. Gross profit shows production efficiency and pricing, while net profit shows overall profitability.
Can a business be cash-flow positive but show a P&L loss?
Yes, a business can be cash-flow positive but show a P&L loss because cash flow and profit are measured differently. P&L takes non-cash expenses, such as amortization and depreciation, into account.
What accounting method should I use for my P&L?
The accrual method of accounting is usually used for P&L statements, but some small businesses use cash accounting, which may be easier to manage.
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