Apr 10, 2021

How to Understand Your Profit and Loss (P&L) Statement

Your profit and loss (P&L) report is your most popular and telling financial document. When it comes to understanding your business’s success at a glance, nothing reveals more than your P&L statement. That’s why it’s the first page bankers and investors turn to when evaluating your business.

This article will walk you through everything you need to know to understand your P&L statement. We’ll cover what it is, how it works, and answers to all the questions likely buzzing through your head.

What Is a Profit and Loss (P&L) Statement

At a high level, your P&L statement explains whether you’re profitable or not. The report begins with your revenue, then lists your cost of goods sold, operating expenses, taxes, etc., and ultimately culminates with your net profit. Within seconds, viewers of your P&L report will know whether your business made a profit or a loss (hence, the name) and what factors contributed to that result.

If the world is going to put this report on a pedestal, you should at least understand the basics. A good understanding of your P&L report will not only help you communicate your financials, but it will also give you quick insights into your business’s financial health. Armed with these insights, you’ll be better positioned to make sound business decisions at a moment’s notice.

Let’s start from the top down.

P&L Statement Breakdown

Year

P&L statements are most effective when used contextually, and that’s why you’ll often see the financials for multiple years on a single report. If a business has been profitable in recent years but then takes a sudden loss, the report often reveals why. Maybe the company rapidly scaled sales but had to invest in more operating expenses to set the business up for future success. A single year of data won’t tell that entire story.

Revenue

Revenue is simply the money you bring in as a result of sales. For your business to be profitable, your revenue needs to exceed your expenses.

Cost of Goods Sold (COGS)

Cost of goods sold, or direct costs, refers to the money necessary to make a sale, like materials needed for production and direct labor costs. You wouldn’t include indirect expenses like shipping or marketing fees.

Gross Profit

Gross profit is the profit a company makes from sales after you deduct the cost of goods sold. The formula for gross profit: Gross Profit = Revenue – Cost of Goods Sold. Gross profit gives you a quick understanding of how much you’re making off each sale, although it doesn’t include fixed costs and other operating expenses.

Operating Expenses

Operating expenses are the costs you incur indirectly from the sale of a product. Think of it as the electricity bill for the warehouse, rent, salaries, marketing expenses, etc. This number does not include your COGS.

Net Income

Net income is all of the money that’s left from your revenue after you’ve deducted your COGS, operating expenses, interest, taxes, and so on. If your expenses exceed your revenue, the negative number is referred to as a loss.

That’s basically all there is to your profit and loss statement, but before you start reading this report regularly, let’s clear up a couple of critical nuances. 

Don’t Confuse Profits With Cash

Many businesses fall into the trap of trusting false profits. This mistake can lead to erroneous financial decisions that damage your cash flow and put your business in jeopardy. Profits on your P&L report don’t mean you have cash in the bank. Accountants record sales in the P&L report even if they were sold on account. That means the transaction isn’t cash yet—it’s Accounts Receivable, which is very different from money in the bank.

Your P&L statement doesn’t tell the whole story, which is why you also have balance sheets, cash flow statements, and other financial reports. Take a retail business, for example. In almost every situation, businesses purchase inventory or build a product in advance of selling it. And the turnover from purchase to sale doesn’t usually occur within the same month. However, the money spent on inventory won’t show up on your P&L statement until the sale occurs. You can see how ignorance of this fact might cause some flawed financial decisions.

What’s the Difference Between a Balance Sheet and a Profit and Loss Statement?

Balance sheets and P&L statements are often used side-by-side when analyzing a company’s financial health, but what’s the difference between the two reports?

A balance sheet reports your business’s assets, liabilities, and equity at a specific point in time. This record gives business owners, investors, and lenders a snapshot view of how effectively a company manages its resources.

A P&L statement summarizes the revenues and costs incurred over a specific period (not a point in time). This period could be monthly, quarterly, or annually. This report provides information to determine whether your business is generating a profit or loss. Diving deeper, it can reveal if you’re generating a profit by increasing revenue or decreasing expenses (or both).

Used together, these statements tell a reliable story about your organization’s operational efficiency, financial consistency, and trajectory. Often, investors and lenders will want to look at multiple statements from different periods to analyze the discrepancies.

Regularly Check Your P&L Statement

Your P&L statement won’t do you much good if you never check it. Make it a habit to do P&L analysis each month to stay up-to-date on your business’s financial health. If you only analyze it quarterly, you could miss out on important opportunities or discover problems far too late.

Using the P&L report alone won’t give you the whole picture, though. Pair this report with your other financial statements to get a more complete view of your company. By understanding your business financials, you’ll be primed to secure the best financing and make the most informed financial decisions for your business.

Frequently Asked Questions (FAQs) About P&L Statements

We’ve covered a lot about P&L statements already, but we want to answer the specific questions you’re asking. Here are more direct answers to everything you’d ever want to know (and more) about P&L management.

What does P&L stand for in P&L statement?

The “P” stands for profit, and the “L” stands for loss.

What is the purpose of a profit and loss statement?

A profit and loss statement summarizes your revenues and expenses to reveal whether you made a profit or loss during a specified period. This information is a quick-and-easy way for you to monitor your business’s health, and it’s also a way for lenders and investors to evaluate your trajectory. 

Why do I need a profit and loss statement?

First, a P&L statement is an easy report to use to check your business’s financial health. It gives you an at-a-glance view of your profitability or losses. Second, it’s legally required for publicly traded companies (in addition to your balance sheet and cash flow statement). Plus, investors and lenders will want to look at your P&L management to determine your financial stability before offering you any capital.

Who uses a profit and loss statement?

Business owners, financial planners, accountants, investors, and lenders—to name a few. Anyone who’s concerned with your business’s financial health and wellbeing will want to look at your P&L statement.

What is an audited P&L?

An audited profit and loss statement is one that’s been certified by a CPA. Audited P&L statements prevent companies from committing fraud by making dishonest claims through incorrect accounting techniques. 

How do I do a profit and loss statement?

Preparing a profit and loss statement is easy when you use a digital bookkeeping system to track your income and expenses. Sunrise helps you create financial reports in seconds by using all your tracked financial data. You can also hire a bookkeeper to prepare your P&L statement for you.

How do I do a profit and loss statement if I’m self-employed?

As a sole proprietor, you’re required to file Schedule C (Form 1040 or 1040-SR) with the IRS during tax season. This Schedule C is essentially your P&L statement. You can complete this form using either the cash method of accounting or the accrual method.

What’s the difference between an income Statement vs a P&L statement?

There’s no difference between an income statement and a P&L statement—the two are the same thing. Income statements are also referred to as statements of income or statements of operations.

Leverage Your Free P&L Reports from Sunrise

You can access free P&L reports when you do your bookkeeping with Sunrise. Whether you are a hardy do-it-yourselfer or want one of our professional bookkeepers to run your P&L for you, you have options with Sunrise.

About the author

Avatar
Jesse Sumrak
Jesse Sumrak is a Social Media Manager for SendGrid, a leading digital communication platform. He's created and managed content for startups, growth-stage companies, and publicly-traded businesses. Jesse has spent almost a decade writing about small business and entrepreneurship topics, having built and sold his own post-apocalyptic fitness bootstrapped startup. When he's not dabbling in digital marketing, you'll find him ultrarunning in the Rocky Mountains of Colorado. Jesse studied Public Relations at Brigham Young University.

Comments

  1. Like know more on pnl

    • Thanks, Kalpana, we’ll make sure our team posts additional information on Profit & Loss statements in future posts. We’re currently working on 2 directly related to that topic. Depending on the activity you’re doing, you may also benefit from reading this article on calculating the value of your business: https://sunriseapp.com/blog/calculate-value-small-business/. If there’s anything specific you’re looking for, don’t be afraid to ask. Thanks!

  2. Very good especially for us in West Africa.

Bookkeeping for your small business.

Simplify your bookkeeping and save money