Create Your Profit and Loss Statement in 4 Simple Steps

Create Your Profit and Loss Statement in 4 Simple Steps

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Whether you’re working as a freelance consultant or managing your own plumbing company, you should know how to create a profit and loss (P&L) statement. This document shows your business revenue and expenses and net income (revenue minus total expenses). It’s a key indicator of your business’s financial health.

Many small business owners and freelancers are hesitant to invest their energy into learning about such topics. After all, you became your own boss so that you can do work you’re passionate about, right? Business finance likely isn’t your No. 1 passion in life. However, a basic knowledge of accounting can make or break your business.

This is especially true for P&L statements. This paperwork allows you to assess the health of your business, identify business trends over time, and make operational changes as needed. This is valuable information that you can use to improve your business success.

Say you fail to correctly calculate your profits, for example. This can make your company look less valuable than it really is. If you hope to sell your business, the sale price will be based largely on the company’s estimated value. If you’ve underestimated your profits, you’re going to end up selling your company for less than it’s worth. You’re essentially cheating yourself.

If you’re just starting, this kind of scenario might seem like it doesn’t apply to you. However, even for new entrepreneurs, it’s important to understand P&L statements and how to create them. As a new business owner, you want to keep close oversight of your financials, knowing where you’re making and losing money. 

Issues with cash flow statements cause 82% of small business failures. An accurate P&L record helps avoid this outcome. The below guide explains how to create a profit and loss statement.

What is a profit and loss (P&L) statement?

A profit and loss (P&L) statement is a document that calculates your business revenue (meaning sales or income) and expenses in a specific period of time. Also called an income statement, a P&L statement essentially tells you whether your business is making money. According to the U.S. Small Business Administration (SBA), “the P&L statement is the best tool for knowing if your business is profitable.”

P&L statements can be calculated monthly, quarterly, and annually. In addition to an annual statement, you should create P&L statements at least every quarter. This is considered a best business practice and allows you to identify time-sensitive trends. You can use your P&L reporting to assess your overall business performance and define areas needing improvement. You can also use P&L statements to identify new growth strategies.


4 Steps for Creating a Profit and Loss Statement

The thought of financial paperwork might make you cringe, especially if you’re not a big fan of math. Don’t stress: The process of creating a P&L statement is pretty easy. There are a few quick steps you need to follow. With practice, you’ll find that P&L statements are straightforward and simple to create. There is even accounting software like QuickBooks to help.

Here are the four main steps:

  1. Establish your revenue figures
  2. Calculate your operating profit/loss
  3. Factor in additional revenue to determine your EBITDA
  4. Subtract EBITDA from interest, taxes, depreciation, and amortization

Step 1: Establish your revenue figures

Revenue encompasses any income your business generates. It includes the total sales that your business makes, whether of products or services. It also includes money that your business received from other avenues, such as selling equipment or through a tax refund. Create a list of these income streams and amounts and tally them up.

If you have just started your business, you may not have revenue yet. In this case, create an estimate. How much money do you expect to make in your first accounting period? You may already have some orders lined up. Forecasting your expected profits and losses will provide a benchmark to measure future business successes and failures.

Establish your revenue figures in the given time frame for which you’re calculating a P&L statement. So, if you’re calculating a P&L statement for Q1, you have to input all your revenue from January, February, and March.

Step 2: Calculate your operating profit/loss

With your revenue defined, you can calculate your operating profit/loss. There is a precise formula to do this:

(Revenue – Cost of Goods Sold) – Operating Expenses = Operating Profit/Loss

Does that look like gibberish to you? Read on as we define each of those terms and break down the formula for you.

Revenue

We covered it in the section above, but here’s a quick reminder: Your revenue refers to all the income your business has generated in a specified time frame. This includes the sale of goods and services and other income streams, like selling old business equipment.

Cost of Goods Sold (COGS)

The cost of goods sold (COGS) refers to materials costs related to the production or sale of your business product or service. It could cover materials costs, for example, or manpower costs related to manufacturing.

For instance, if you run a coffee shop and sell a to-go coffee for $3.50, you aren’t making a full $3.50 off that sale. You have to subtract costs like the cost of coffee beans and the to-go cup. Another example: If you sell a product that you don’t manufacture yourself, you have to factor in the supplier costs.

Sometimes referred to as “direct costs,” COGS only cover expenses related to the sale or production of your given product or service. They don’t cover indirect costs, like accounting, rent, and marketing. Find out more about the difference between direct and indirect costs.

Gross Profit

To get your gross profit, subtract your COGS (direct costs) from your revenue:

(Revenue – COGS) = Gross Profit

Operating Expenses

Finally, you have to calculate your operating expenses. These are funds required to keep your business running on a day-to-day basis. Operating expenses include office rent, office supplies, advertising and marketing costs, utilities, phone and internet services, insurance, and payroll.

To complete the formula and get your operating profit/loss, you subtract your total operating expenses from your gross profit. Here’s the formula:

(Revenue – COGS) – Operating Expenses = Operating Profit/Loss

Step 3: Factor in additional revenue to determine your EBITDA

EBITDA stands for “earnings before interest, taxes, depreciation, and amortization.” This is another measure of profitability. Depreciation refers to any reduction in the value of your business’s assets, such as equipment or machinery. Amortization refers to an accounting technique that may be used to decrease the book value of an intangible asset or loan over a defined period.

A rough calculation of EBITDA would involve subtracting your operating expenses, cost of goods, and depreciation from your total revenue. However, precisely calculating and factoring in depreciation and amortization requires advanced accounting experience, so at this point, it’s best to turn to a professional. This guide provides more details on amortization and depreciation, in case you’re curious.

Step 4: Subtract EBITDA from interest, taxes, depreciation, and amortization

Finally, to calculate your operating profit/loss, you must subtract the EBITDA from interest, taxes, depreciation, and amortization. Here’s the formula:

Net Profit/Loss = EBITDA – (Interest + Taxes + Depreciation)

Again, at this point, you’re likely best off leaving the job in the hands of an accountant or bookkeeper. Miscalculating some of these points, like depreciation, can have implications for income taxes. The Internal Revenue Service (IRS) has guidelines governing depreciation of business vehicles, for example, which a skilled tax professional will be well-acquainted with.


Sample Business Profit and Loss Statement Template

Going through an example profit and loss financial report can help clarify the process. Here, we take you through a scenario. Say you work as a freelance graphic designer. You’ve just finished your first quarter of business and want to create a profit and loss report. You follow the steps above.

First, you need to establish your revenue. You sold $18,750 worth of graphic design services in your first three months as a freelancer. You also sold an old computer that you no longer used for work, bringing in another $250. In total, your revenue for the quarter was $19,000.

Here’s how your P&L balance sheet looks so far:

Sales, Services: $18,750

Sales, Other:       $250

Total Sales $19,000

Next, you want to calculate your operating profit/loss. You calculate your COGS (design software, printing production costs, paper costs, etc.) and see they added up to $2,000. You subtract that from your revenue to get a total of $17,000. That’s your gross profit. Next, you calculate your operating expenses. So far, your P&L statement looks like this:

Sales, Services: $18,750

Sales, Other:       $250

Total Sales $19,000

Cost of Goods Sold:   $2,000

Gross Profit: $17,000

Next up: operating expenses. You paid $3,000 for rent on your office space and $300 for utilities. You don’t have any employees yet, so you don’t have payroll expenses. Since your business is new, you don’t have depreciation and amortization costs to account for yet. Here’s what you’ve got now:

Sales, Services: $18,750

Sales, Other:       $250

Total Sales $19,000

Cost of Goods Sold:   $2,000

Gross Profit: $17,000

Operating Expenses

Payroll:             $0

Rent:   $3,000

Utilities:       $300

Depreciation and Amortization:             $0

Total Operating Expenses:   $3,300

Now, a rough calculation of EBITDA would involve subtracting your operating expenses, cost of goods, and depreciation from your total revenue. So, that’s $19,000 (total sales = total revenue) minus $2,000 minus $3,300, equaling $13,700.

Sales, Services: $18,750

Sales, Other:       $250

Total Sales $19,000

Cost of Goods Sold:   $2,000

Gross Profit: $17,000

Operating Expenses

Payroll:               $0

Rent:     $3,000

Utilities:         $300

Depreciation and Amortization:               $0

Total Operating Expenses:     $3,300

EBIT/Operating Profit $13,700

A bookkeeping professional can then factor in interest, taxes, and depreciation to complete your profit and loss statement using the formula: Net Profit/Loss = EBITDA – (Interest + Taxes + Depreciation). The final statement with all line items accounted for might look something like this:

Sales, Services:                                                    $18,750

Sales, Other:                                                                $250

Total Sales                                                              $19,000

Cost of Goods Sold:                                             $2,000

Gross Profit:                                                         $17,000

Operating Expenses

Payroll:                                                                                  $0

Rent:                                                                             $3,000

Utilities:                                                                          $300

Depreciation and Amortization:                            $0

Total Operating Expenses:                              $3,300

EBIT / Operating Profit:   $13,700

Interest Expense:                                                      $700

EBT / Earnings Before Taxes:                      $13,000

Taxes (assuming a 15% tax rate):                 $1,950

Net Income:                                                          $11,050 


What You Can Learn From a Profit and Loss Statement

So, what’s the point of all those numbers? Your P&L financial statement contains a lot of valuable data. Here are three things you can learn from a P&L statement:

  • The financial health of a business
  • Business trends over time
  • Operational changes or improvements needed

Financial Health of a Business

Simply put, the P&L lets everyone know what the “bottom line” is. A positive profit statement means you are making money. However, if your gross profit is low or negative, it’s time to reassess your business model. Do you need to increase sales? Cut back on operating costs? Identifying the problems allows you to fix them.

Your business’s financial health may also be of interest to external parties. For example, if you approach lenders to take out a loan for your business or take out a business credit card, such documentation can secure a favorable loan or interest rate. Demonstrating strong profit margins is also critical if you ever hope to sell your business.

Business Trends Over Time

To truly excel, business owners need to look for trends in their business over time. A P&L statement helps identify important fluctuations that can inform smart business decisions. Say you run a holiday catering business, for example. Comparing your quarterly P&L statements, you see that Q4 is your strongest-performing quarter. That makes sense since Christmas, Thanksgiving, and New Year’s all fall in this period.

However, you’re surprised to see that Q2 also performs strongly. Reviewing your records, you realize you cater to a lot of graduation parties in May and June. With this knowledge, you expand your Q2 marketing to capture more of this business.

Operational Changes or Improvements Needed

A significant portion of the P&L statement is dedicated to operational details. This can help you identify areas you’re spending too much on, such as rent or payroll. Alternatively, you may find that you can afford to invest more in operating expenses (in the interests of expansion). For example, if you started your small business from home but want to expand with your own office space, you can use your P&L statement to determine if this is feasible.

What to Do Once You Have Your First Profit and Loss Statement

Now, you know the basics of how to create a profit and loss statement. With the information you gain from your P&L statements, you can make important immediate business decisions, like whether you can afford to move to a larger office space or hire new employees. You can also make more “big picture” decisions, from planning your taxes to revamping your growth strategy.

ZenBusiness can support your business operations with educational resources. Get more tips on running a business.

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