Profit & Loss Statement
A profit and loss statement is one of the most important reports for any business, whether it be a large corporation, a small business, or even a Sole Proprietor, because it shows the profit (or loss) that a business is making. It is also called the Income Statement.
Is it making a profit or a loss? Is it earning more income than spending on expenses?
This statement, like the Statement of Cash Flows, is like a video clip of what happened over a specific period of time (usually a month, a quarter, or a year) in the business.
The Profit and Loss Statement is crucial in determining what (if any) annual tax must be paid by your business to the government.
The Profit and Loss Statement is only as accurate as the data input into your bookkeeping or accounting system on a daily basis, so it is vital that your daily or weekly bookkeeping is completely accurate. Inaccurate capturing of transactions in your bookkeeping system will lead to an incorrect Profit and Loss Statement, which will then give you a wrong picture of how your business is actually doing, which, in turn, may lead to incorrect or bad business decisions.
Other Names
The Profit and Loss Statement may also be called the Income Statement, the Income and Expenses Statement, the Statement of Financial Performance or even the Statement of Comprehensive Income.
What Will I Find in a Profit and Loss Statement?
The Profit and Loss Statement essentially shows you how your business has done over a specific period of time. This Statement relies on 2 types of accounts in your accounting system: Revenue Accounts (also called Income Accounts), and Expense Accounts.
| Revenue Accounts | This includes all accounts that reflect amounts a business earns by selling services or products. It also includes ‘Other Revenue’ Accounts, such as interest received, etc. |
| Expense Accounts | This includes all accounts that reflect expenses in the business. In plain language, what you paid for the stuff you used and had to pay for or charge to run your business. Some examples: office supplies, salaries & wages, advertising, utilities, building rental, telephone, etc. |
There are 4 major sections in the Profit and Loss Statement. They are:
- The Heading
- The Revenue Section
- The Expense Section
- The Final Calculation of a Profit or Loss
Let’s look at each of these sections in turn:
The Heading
The Heading contains 3 bits of information:
- The Title of the Statement
- The Name of Your Company
- The Period Covered by the Statement
There are a number of statements available from your accountant or bookkeeper that will show different aspects of the financial performance of your business. It is important that you know what statement you are reading, as this will determine what kind of information you will receive in the report.
It is also important to note the period being reported on. The Profit and Loss Statement for a small business usually reflects transaction for a period of 1 year (most often the financial year of the business), but you can also request a Profit and Loss Statement from your accountant for a period of 1 month, 1 quarter, etc, depending on what you need the information for.
Example 1: Simple Profit & Loss Statement
The length of the Expenses Section of the statement depends entirely on what expense categories you have in your business. There may be more or fewer expense categories in your Profit and Loss Statement.
Explanation of Example 1
Heading Section
As you can see above, the Heading Section is straightforward. It shows the name of our example company, the Title of the Statement, and the period of business reflected in the Statement.
Income Section
In this section (everything in the blue block), you can see what income Doug’s business has done for the year in question. Doug likes to separate different streams of income into different line items, so he can see at a glance how he is doing.
Doug sells plants, garden ornaments, seeds, etc, to clients, and this is listed under Product Income. His Landscaping, lawn mowing and other services are listed under Services Income. Then, he also does garden design layouts for clients, which he lists under Other Income. Finally, his business received interest from the bank, listed under Interest Received. The total income for the year was 152 175.
Expenses Section
All of Doug’s business expenses are listed in this section. (everything in the red block.) Here you can see what he spent for each category of expense. The total expenses for the year were 146 520.
Some quick observations:
All of the garden products that Doug buys for resale are listed under the category Garden Products. The amount of 48 200 is what it cost Doug to purchase the products that he sold for 62 500. The Maintenance & Repairs category shows what it cost Doug to keep his machines going, including servicing and repair of machines, etc. The other expense categories explain themselves.
Finally, Doug’s accountant calculated the net profit for the company for the year. Doug’s business made a total Net Profit of 5 655.
152 175 – 146 520 = 5 655
This statement layout may be all you need for your small business.
Example 2: Profit & Loss Statement
In our second example, we will again use Doug’s business, but this time we will structure the Profit & Loss Statement a little differently. In this example, Doug wants to know what the direct costs were for the products and services he sold during the year, and also what ‘Overheads’ there were. (Overheads are expenses in a business has that are not dependent on sales.)
Explanation of Example 2
In this example, you will note a change in the structure of the statement. The numbers are the same, and the end result (or the ‘Bottom Line’) remain the same. In this example, Doug wants to know what the direct costs of his sales are, and also the ‘Overhead’ costs of running his business.
You will notice that the Heading section, as well as the Income section remain the same. No difference there!
Cost of Goods Sold
There is a new section, called Cost of Goods Sold (COGS). Cost of Goods Sold includes all expenses in the business that directly relate to the sales or revenue income of Doug’s business. Doug sold 62 500 in products, and those products cost him 48 200. Also, the maintenance, servicing and repairs to Doug’s machinery during the year is a direct result of those machines being used to produce sales, so that expense is listed under Cost of Goods Sold.
In this example, Doug’s total revenue of 152 175 cost him 71 680 in direct costs (Put differently, if Doug didn’t have any revenue in his business for the year, he would not have spent that 71 680!)
If you deduct the Cost of Goods Sold from the Gross Income, then you will see that Doug made a Gross Profit of 80 495
152 175 – 71 680 = 80 495
But, it cost Doug a further 74 840 to run his office and keep his business going. You may argue that Vehicle Expenses should go into the Cost of Goods Sold section, and you would be correct. However, Doug also uses his vehicle to run around to suppliers, see potential clients, etc, so only a portion of the Vehicle Expenses would go into Cost of Goods Sold. Doug doesn’t keep a detailed log book for his vehicle, so is happy that the full amount for Vehicle Expenses is reflected where it is on the statement.
So, at the end if it all, the Profit & Loss Statement still shows that Doug made a Net Profit of 5 655, the same as in Example 1, but now Doug know exactly how much he spent directly in producing the income, and also how much he spends on running his business office.
Summary
As you can see, the Profit & Loss Statement can tell you a lot about how your business is performing. Speak to your accountant if you want to track specific income or expenses, and ask her to design your Profit & Loss Statement so that it tells you what you need to know about your business.
With the advent of online, cloud accounting software platforms, it has become much easier to track income and expenses, and report design is open to a lot of tweaking and re-arranging so that it makes sense to you in your business.
If you are thinking of outsourcing your bookkeeping requirements, check out our Services page to see how we can help you, or contact us today. We will be happy to meet with you to discuss and help plan your future success.