Find out where you’re losing money
A profit and loss statement can reveal a lot about the health of your business. Because it shows your revenues minus your expenses and costs, you can easily chart your profits (or losses) over time to see whether things are trending up, down, or staying the same.
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What is the purpose of a profit and loss statement?
A profit and loss statement provides an overview of monthly, quarterly, or annual profits or losses. These financial reports, along with a balance sheet and cash flow statement, are what you’ll generate regularly to provide an ongoing picture of your business’s financial health. If you work with a CPA or accountant, are seeking investment, or trying to get a loan to help grow your business, you’ll need these reports so they can accurately assess your business’s level of risk and profitability.
Compared to a balance sheet, which provides a snapshot of your small business’s assets, liabilities, and owner’s equity, a profit and loss statement simply summarizes total revenue and expenses within a specific time. A cash flow statement, on the other hand, records your business’s cash-in from operations, investment, and financing.
Further reading: How to Read and Analyze a Profit and Loss Statement
What’s included in a profit and loss statement?
Here’s what these documents typically include:
- Sales revenue: Total revenue for the time period you’re reporting on. This will depend on the type of accounting you use, cash or accrual, and how your business recognizes revenue.
- Cost of goods sold (COGS): The cost of goods sold equals the total cost of producing the products or services your business provides. These are direct costs only: raw materials, labor (or employee wages), and shipping expenses.
- Expenses: Also called operating expenses, this is the amount spent on things like rent, marketing and advertising, equipment costs, and other expenses you incur to keep your business running.
- Gross profit: Your revenue minus COGS.
- Net income: Your income before taxes.
- Earnings per share (EPS): Your net income divided by the full number of shares in the specified reporting period.
- Depreciation: The value lost by common assets like equipment, inventory, and property throughout the specified reporting period.
- Operating earnings, or earnings before interest, tax, depreciation, and amortization (EBITDA): The earnings from the specified reporting period after all internal costs are subtracted, but before external costs (tax, depreciation, and amortization) are subtracted.
Why are profit and loss statements important for small businesses?
When it comes to being self-employed, consistently generating P&L statements is necessary for any business owner looking to improve (and sustain) their long-term financial health and business profit.
There are three ways a profit and loss statement achieves this:
- They highlight financial trends: Profit and loss statements provide an accurate and up-to-date indicator of a business’s financial health, and help you track your performance over time.
- They help you stay tax-compliant: This report can help you and your business stay in line with tax regulations and correctly file your income taxes.
- They indicate profitability: Profit and loss statements clearly show your business’s profitability. In fact, Operating Earnings are considered by many accountants to be the best indicator of a business’s financial performance. In addition, businesses looking for investors will also need to present their P&L (although when a P&L is used externally—for example, to secure a loan or to court investors—it’s referred to as an income statement).
Income statements are vital for ratio analysis, valuation, and equity research; analysts and research houses use them to perform an in-depth corporate evaluation. Based on the data you generate via these reports, you can decide where to put your marketing dollars, which goods or services to cut or expand, and whether to increase your ad budget.
Further reading: Understanding Income Statements vs. Balance Sheets
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