What Is A Profit and Loss Statement?
The total summary of the revenue and expenses of your business is referred to as the Profit and Loss Statement (P&L), statement of operations, or income statement. It is an essential accounting document that measures all your financial activity to answer the key question: “is your business actually profitable?”
Why It Is Vital For Your Business
Business owners, accounting programs, and accounting professionals use P&L statements. This sensitive document lays the foundation for decoding the profit/loss of your company, along with your pattern of expenditure, cash flow, and revenue.
Why does it matter? Take a look at its importance.
- It helps determine the current efficacy or financial status of the company.
- It creates a financial forecast and gives ample clarity.
- This document gives you a reality check of your finances.
- Making operational changes and commitments is safer and easier with a macro-view of your finances.
- Tax-related decisions and actions become more manageable.
P&L Statement: A Breakdown
New to profit and loss statements? For most self-employed enterprise owners, accounting basics are self-taught. All you need to understand are the common entries on P&L statements to build one on your own, as shown below.
Revenue
The statement summing up your profits and losses always contains an item called ‘revenue’ that shows the sum total of sales generated during the period of observation.
For example, if in a given month there were 150 sales of bow ties priced at $5 each, 50 lace flowers priced at $3, and 50 bridal veils priced at $75, the total revenue of $4,650 will be entered into the P&L statement, as the bottom line revenue for that period of time.
Expenditure
Expenses that are part of the business are included under this tab. This includes payroll, cost of goods, insurance, taxes, rent, and so on.
For example, if you are paying $300 for rent, $100 for insurance, $50 for internet, $2,000 for payroll and $400 for miscellaneous expenses, your total expenditure on this tap within the profit and loss statement will be $2,850.
Direct Costs
Also referred to as the Cost Of Goods Sold (COGS), direct costs are the cost of directly producing and selling a product.
For example, suppose the raw materials used to make a long bridal dress if you are a tailor cost $5,850. However, it might be $7,500 for a boutique owner when sourcing the same dress.
Keep in mind that several indirect costs like labor expenditure, sales force, internet, marketing, rent, training, insurance, and so on are not included in this category.
Gross Profit (Margin)
When you subtract the total COGS from the total revenue generated from the sales of the products, the resultant value is called the gross profit margin. Also referred to as the gross margin ratio, you will notice this is typically shown in percentages.
For example, if the direct costs for Simon’s VHS recovery business are $850 and his revenue is $6,500, the gross profit margin is $5,650.
The gross profit margin percentage would be calculated as: gross profit margin/total revenue x 100, which is [(5650/6500) x 100] = 86.92.
Hence, the gross profit margin for Simon’s VHS recovery business is almost 87%.
Operating Expenses (OPEX)
This refers to the standard costs of running a business. The common OPEX you see on P&L statements include payroll, utility costs, admin costs, rent, office equipment cost, insurance, and adverts.
For example, the operating costs of Miriam’s Lash Salon consist of $2,000 payroll, $1,200 utility costs, $1,000 rent, $250 insurance, and adverts for $50. Hence, the total OPEX will be $4,500.
Additions
- EBIT or Earnings Before Interest and Tax refers to your total income before deducting tax or interest expenses. The easiest way to find out the EBIT is by subtracting the cost of goods and OPEX from the total revenue. EBIT is also equivalent to your net income plus interests and taxes.
- Depreciation is the value of the equipment that diminishes or reduces overtime. For example, if you are a marketing expert who runs your own business via HP PC, the value of the PC that diminishes over the course of one year is the depreciation of equipment for your business. For example, laptops typically depreciate at a rate of 33.33% per year.
Finally: Net Income
The final step in creating a P&L statement is the calculation of your net income. You can do so by reducing the indirect expenditure of your business from the gross profit you calculated earlier.
For example, if your gross profit is $8,000 and the indirect expenditure is $2,500, your company is running a profit. Conversely, if your indirect expenditure is higher than the gross profit such as $12,000 in this case, P&L will show that your business is running a loss.
Conclusion
If you are a freelancer or running a small business, knowing how to interpret a profit and loss statement is essential in the long run.
Once you know common accounting terms in P&L statements such as revenue, expenditure, direct costs, gross profit margin, gross profit margin percentage, OPEX, and net income, it is easy to read such a report and stay on top of your true financial status.
With invoicing programs such as FreshBooks, a P&L statement is automatically generated with a user-friendly layout which is easy to understand.
