A profit & loss statement can help a business to manage its profits by cutting costs & driving revenue.
To understand the workings of a business, you must understand its Profit and Loss (P&L) statement. How a company records its income and expenses and determines its bottom line can tell you everything from what specific products or services are most profitable to how well management manages the business as a whole.
The information contained in the P&L statement will also give you insight into how a company is capitalized, since an understanding of debt versus equity is essential for investors. And let's not forget about taxes. After reading an entire P&L statement, you should be in good shape to fill out your tax return each year.
Learn how to better utilize this report.
What Is a P&L Statement?
A profit and loss statement is a financial document that discloses profits and losses for your business within a particular time. It compares total revenues, total costs, and general expenditure.
Because it's a summary of the company's revenue, expenses, and profits and losses, a company can condense expenditures or augment sales to add to its profits using it.
Overall, profit and loss statements do an adequate job of summarizing anticipated earnings and expenses. They use standard terms. Ultimately, it's up to the entrepreneur / small business owner to understand them fully and analyze their meaning to make educated business decisions.
Profit and loss statements encompass the following primary categories:
- Cost of sales
- Advertising and marketing
- Selling, general and administrative costs
- Net income
- Research and development
As mentioned, P&L statements are created after some time, say after a month, quarterly, or after a fiscal year. And this makes it different from a cash flow statement.
Types of P&L statement
The P&L statement is made from revenue recognition, matching and accruals accounting principles. And the types of P&L statements are:
- The cash method and
- Accrual method.
If you have a small business or want to manage your finances, the cash method applies. It's also called the cash accounting method, significant where cash is used in the business. It only accounts for cash received or paid.
With this method, revenue is recorded as it is earned. Here, your business records money yet to be received. If your company deals with products and services, a P&L statement records the revenue before receiving the payment. And liabilities too are accounted for even before you spend any.
Why Prepare a Profit and Loss Statement?
P&L are prepared to:
- Identify if your business is doing fine. You might be running a business that's slowly sinking into deep waters. A profit and loss statement will help you screen operations to ensure all is well. So, a regularly prepared P&L statement gives you opportune and vital data concerning revenues and expenses as the business owner. It makes it easy for a third party to assess your capability to manage and use your company's assets.
- Fulfill the requirements of the Internal Revenue Service (IRS). The IRS runs tax collection and implementation of related laws in the US. So, P&L is a critical financial requirement by the (IRS). Any business needs a P&L for recording purposes and operating a business. Remember, it evaluates taxes on profits earned.
How to Use a Profit and Loss Statement to Improve Your Business
When looking at your business, it is essential to understand what is happening on the financial side. One way to do this is by looking at your profit and loss statement.
A profit and loss statement, or income statement, is a document that shows your business's income and expenses over a specific time. This can help you understand how your business is doing financially and where you may make improvements.
When reviewing your profit and loss statement, there are three key things to look at: revenue, expenses, and net income. They help you understand where to improve your business.
- Revenue is everything you receive from selling goods and services to customers or other activities, minus any discounts you may have offered them (your listed price minus the actual price you earned).
- Expenses are what you spend money on to run your business, including labor. Some of these expenses are variable—that is, they change when your business does (labor)—and some aren't (rent).
The P&L is more than a financial report. It is a powerful tool for evaluating your business and bringing strategic insights to bear on the problems of new products, market positioning, growth, and crisis management. Above all, it puts you in the driver's seat of your business, where you're in charge of the firm's fate.
Gain financial clarity from the experts
Does the idea of reviewing P&L statements or other financial documents feel overwhelming? Even if you’re comfortable creating your own financial reports, a professional can save valuable time, provide critical insight and ensure you can focus on other areas of your business.
Focused Energy are outsourced finance, accounting, and CFO experts who specialize in small and medium-sized businesses. Contact one of our financial experts for a free consult today.