How Do I Prepare a Profit and Loss Statement?

Profit and Loss on notebook at office desktop

A Profit and Loss Statement simply refers to the money that has ‘passed’ through the books of a company. It will show the profit or loss of the company once they pay all the expenses and account for all the comprehensive income. Of course, the data coming out is only as useful as the data going in, so it pays to ensure the person entering it is doing so correctly.

What is a Profit and loss statement?

P&L statements have many other pseudonyms. Like Income Statements, Statement of Operations, Earnings Statement, and Operating Statement. Regardless of how you label, its purpose is the same in all instances. Put merely, they summarize a company’s past performance over a predetermined time period. Most companies create them for the quarter and the end of the year.

They also show the expenses from earning the revenue, and overall, they let the reader see if the company has made a profit or had a loss.

Here’s a much-general breakdown of a P&L and what is included:

• Gross Revenues minus Returns and Allowances = Net Revenues

• Net Revenues minus Cost of Sales (The amount of money you spent to produce the goods/services) = Gross Margin/Gross Profit

Gross Margin/Gross Profit minus Operating Expenses (Expenses that you cannot directly link to the production of the goods/services) = Income from Operations (Operating profit before interest and income tax expenses)

Income from Operations – (+/-) Income/Expenses from non-operating activities (This includes interest income/expenses or income unrelated to the primary business purpose) = profit before income taxes

Profit before income taxes minus Income Tax = Net Profit/(Loss)

Investors often use P&Ls in conjunction with a balance sheet and cash flow statement to see the general financial health of a company.

However, P&L statements alone do not tell the whole story. They only tell you how the company did for that period. The profit and loss statement format also matters because some income statements even leave out other data such as intangible assets, like customer loyalty or brand recognition (goodwill).

In other words, the P&L does not fully detail a company’s worth. It is only one of the three financial statement one must look at; however, it is one excellent starting point.

How to Complete a P&L

A P&L is a necessity to measure the sales and expenses of a company over a certain amount of time. This allows someone to calculate the progress of the company over that time. Some categories that fall under a P&L are net sales, costs of goods, gross margin, operating expense, and net profit. Some other data that needs to be in the statement is net sales, cost of sold goods, administrative/selling expenses, and other forms of operating income or expenses.

Any returns or discounts from total sales of a given period give us the net sales of the business. Another name for the cost of goods is the cost of sales and is the total amount for the products you sell.

There is no cost of goods sold when it comes to service companies, mainly because instead of inventories of products, they receive income from fees, commissions, and royalties. The selling and administrative expenses and general expense sections of the income statement will include the costs of generating services. In the case of retailers and wholesalers, they use a direct or indirect method to calculate the cost of goods sold. Deflating sales figures, while not exact, can also help to get the cost of goods sold via estimates or “indirect” computing. When it comes to manufacturers, calculating the cost of goods sold varies a lot from the methods by retailers and wholesalers, and they use two categories under the cost of products sold namely, direct cost and indirect cost.

The method for getting direct costs is similar to that of retailers, involving costs of inventory at the beginning and end of the accounting period. Indirect costs require the input of indirect labor costs, and its compilation is separate, which is why you add it later to the statement. The gross margin, or gross profit, can be computed after the cost of goods sold and net sales are input in the statement.

Selling Expenses and General and Administrative Expenses should also be in the statement. These are the Expenses that you incur directly or indirectly when making sales and are known as Selling Expenses. General and Administrative Expenses, however, account for all the operating costs that surround the production of the product sold. Management controls such expenses, and hence, you call them managed costs.

Selling and Administrative Expenses subtracted from Gross Margin gives us the Net operating profit, which needs to be entered in the statement as well. The final items that need to go into the statement are income, other expenses, and income taxes. Income from interest, dividends, and so on constitutes other income. Other expenses include losses from indirect causes, and the difference between other income and additional costs is a plus to net operating profit to compute the net profit of the business before income taxes.

Finally, we get the net profit by subtracting Income taxes from net profit before income taxes.

Thus, a P&L is extremely important as it shows every detail of the business in a single glance and, as such, should be compiled frequently to keep track of the finances of the company. Moreover, while you can prepare a statement from scratch, you may also download a profit and loss statement template that can make the job easier.

How to Read a P&L Statement

There are numerous reasons that companies prepare a P&L each month, and it is critically important for you to understand them and the figures in the P&L. Below is a very simple but critical way of looking at P&Ls.

The Scenario

Let’s say that a child named Billy opens a lemonade stand. He buys two dollars’ worth of lemons, spends a dollar on sugar, and another dollar on cups. He then makes his lemony drink and opens a stand, selling them for $1 each. By the end of the day, Billy has sold his entire inventory, brought in $20 worth of sales, and shows a net profit of $15.

Our Initial P&L

Gross income $20.00

Expenses $5.00

Profit $15.00

The Adjusted Profits

If all P&L statements were this simple, we wouldn’t need accountants, but here is where the math gets trickier.

Billy continues his lemonade stand for the week, spending $5 each morning on supplies and making an average of $20 in sales. However, by Thursday, his parents realize how good his business is and decide that they should be paid for their efforts in Billy’s success.

His father spent $70 in wood to create the stand plus six hours’ worth of labor; and his mother provided Billy ice all week. She also used an entire printer cartridge worth of ink, making him flyers, and used a tank of gas for the grocery store trip each day. In actuality, Billy’s $105 weekly profit cost the ones around him $280 in products and labor, and he’s yet to even think about Uncle Sam or sales tax.

Our New P&L

Gross income $105.00

Inventory $35.00

Marketing $40.00

Labor $50.00

Supplies $110.00

Misc. Expenses $40.00

Total Profit/Loss $170.00

Corporate Adjustments

Now technically Billy is starting week two in the hole about $170, but in reality, he has $105 in his pocket because he has yet to deal with his expenses.

Businesses use this same strategy when calculating profits and losses. Since Billy was not much of a financial whiz at seven years of age, he visits a tax accountant that is much more familiar with what he needs to survive his sudden influx of expenses. They decide to place his mother on a weekly salary of $50 to cover her printing and fuel costs. The father agrees to wave his labor costs in exchange for a payment plan that would reimburse his expenses. Since financing is suddenly available, they decide to open two more locations within the area that would employ Billy’s siblings at $5 per day.

With this expansion, he can negotiate a better rate on lemons with a local farmer, buy the sugar wholesale, and use a cross-marketing campaign that will quickly build sales. Billy also applies for a business license, registers to pay sales tax, and incorporates his business to protect his personal assets.

Examining the Fine Print

On paper, Billy is showing that his newly founded corp is making a steady profit of $27.25 per week. Still, if you look just a little bit closer, he is also drawing a weekly salary of $70.00 that is now a business expense.

So this is how our profit and loss statement template looks like now.

Gross income $395.00

Inventory $78.00

Marketing $70.00

Hourly labor $70.00

Salaried Labor (including Billy) $120.00

Mortgage Payment $10.00

Taxes $19.75

Total Profit/Loss $27.25

More P&L complex spreadsheets will include stock options, corporate buyouts, revenue sharing, equipment and building depreciation, and hundreds of other factors. But once you understand the basics, it will be that much easier to decipher the complex ones.

FAQ

Is p&l same as income statement?

The same concept, the same process, and the same function of having recorded all the total income and total expenses of a determined period of time in a business. In other words, we can say that it is the same concept. We can abbreviate P&L as profit and loss. No matter the term adopted, the important point is to apply it, analyze the results, and raise awareness of the financial health of our business in order to take new steps and visualize the future. We can find within an income statement the total expense and total revenue. This takes into account all types of expenses such as overhead expense, administrative expense, tax expense, or interest expense. Likewise with the business’s revenue, which is the net income and gross revenue that can be earned from sales or loan proceeds.

What is margin in project management?

Recognizing a profit margin is vital for succeeding in any project management into any firm. A profit margin or margin is the percentage of some currency collected by subtracting the cost of a company’s revenue. A margin in the project management fulfills the function of protecting the dates of the commitments that the project has (a partial or a final control). It is very useful to have some tools to create schedules to set and determine the net profit margin of a project. Moreover, in a business, there are two forms we can increase our gross profit margin: trying to increase the price or reduce earnings. To sum up, a margin is a percent at any rate.

How do cash dividends impact financial statements?

Cash dividends are payments from a company’s profits to its shareholders. When cash dividends are paid to the company’s shareholders, two journal entries are made to record the transaction. These cash dividends impact the financial statements as a company pays dividends and the results of the transactions decrease assets and net worth. This is due to the fact that these remittances reduce cash (a short-term asset) and retained earnings, which are an integral part of a statement of equity changes. In summary, it is important to understand that cash basis dividends are the outflow of cash to a company’s shareholders and are recorded as a reduction in the cash and retained earnings accounts.

Who is responsible for creating p&l statements?

The person in charge of the work of preparing the profit and loss statement has to be someone with the right financial knowledge. It can be the business owner, but it is recommended to have a certified public accountant, as they can take care of the cash flow statement and analyze the financial statement of a company. However, the more professional the work, the better the quality of the preparation of the p&l. Accountants often use programs such as Excel for this type of duty, it is not complicated for them and the result is efficient. In addition, it depends on the performance of the company that the p&l has to be prepared as there is the option concerning doing it monthly or annually. 

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