Monitor your company’s bottom line using profit and loss statements.
Profit and loss (P&L) statements are a staple of annual reports and bookkeeping. But they can do much more than that. Regularly generating a (P&L) statement is an effective way to track your business’s financial health. It helps you easily see whether you’re becoming more profitable or losing funds.
Here, we’ll explore the key components of a P&L statement for small business and give you an example to reference as you create your own statement.
What is a P&L statement?
A P&L showcases a company’s income and expenses over a certain time period. Typically, a business makes a P&L statement quarterly or annually — but they also can be done more frequently.
Consider reviewing a few recent statements together to look for trends. This can be particularly helpful if you’re weighing any big financial decisions. Detailed P&L records can also help when it comes time to file tax returns for your business.
Creating a P&L statement for small business
If you use accounting software, you may generate P&L reports by simply clicking a button. But it’s important to understand what goes into them as if you were running the numbers yourself. There are two main parts of a P&L report: income and expenses. However, the order in which things are calculated is designed to give you a better understanding of your business and operations.
The first thing reported on a P&L statement is the business’s revenue from sales. Other forms of income — such as investment income — are factored in later.
2. Cost of goods sold (COGS)
Next, businesses that sell goods must figure the cost of the goods they’ve sold. This should include any materials, transportation, or production-related expenses that your business pays before you can sell a product.
3. Gross profit
Subtract COGS from your sales to determine gross profit over the given timeframe. For example, if the COGS for one of your products is $10 and you sell the product for $100, then one sale will net you $90 in gross profit.
Your gross profit can give you a sense of your core business before factoring in overhead and other costs.
4. Other income
This section includes any income the business may have earned outside of day-to-day activity, such as income from interest, dividends, rents, gains from the sale of capital assets, etc.
Expenses are next. These are expenses tied to running your business, and not those tied to the creation of specific products (which were covered in COGS). This is where you’ll see payroll, office supplies, payments to lawyers or accountants, interest paid on any loans, advertising costs, and more.
One thing to keep in mind: If you are purchasing an asset (equipment, a computer, a car, etc.), it’s considered a capital expenditure, and the accounting is different than more basic expenses.
6. Net profit or loss
Take your gross profits and add any extra income, then subtract your expenses. This gives you your net income — a positive net income is a profit; a negative net income is a loss. Even businesses that have high gross profits can post losses if their expenses get out of hand. And this is the type of thing you can look for when you reference your P&L on a regular basis.
7. P&L example
Consider a small pizza restaurant with $100,000 in yearly sales. The restaurant’s COGS includes ingredients and packaging and comes to $7,000. (Since the restaurant’s staff is on payroll, they get paid regardless of the number of pizzas sold. That means labor wouldn’t factor into COGS; it will be factored in later as a payroll expense.)
The pizza shop owns their building and collects rent from a tenant, which supplies $5,000 in additional income.
Sales ($100,000) minus COGS ($7,000) equals gross profit of $93,000.
Gross profit plus additional income ($5,000) equals total gross profit of $98,000.
Payroll ($52,000) plus insurance ($11,000), advertising ($7,000), taxes ($2,000), and interest ($1,000) equals total expenses of $73,000.
Gross profit ($98,000) less total expenses ($73,000) equals a net profit of $25,000.
This example is meant to be illustrative, and for a new business, a profit margin of 25% is considered high. (Turn this into a percent by dividing your net profit by your gross profit and multiplying by 100.) Plus, some industries have higher profit margins by nature.
Look up what an average profit margin is for your industry and use the P&L reports you’re running to understand how you stack up. If your profit margins are higher than your industry, see if you can maintain that margin as you grow. If they’re below the industry standards, see if you can look up how similar businesses have cut costs or managed to boost revenue. It’s also a good idea to watch your P&L statements over time to help you understand how your business is developing.
Once you’ve gotten into the habit of creating monthly, quarterly, or annual P&L statements, you’ll be able to monitor your company’s net profits or losses over time to help you better understand your company’s financial health and how you can adjust course for the long term.