Do Self-Employed People Need a Profit and Loss Statement?

A profit and loss statement for self-employed workers is essential, especially at tax time. But exactly what is it? And how do you create one? In this guide, we’ll walk you through the essentials of profit and loss statements.

What is a profit and loss statement?

In the context of taxes, a profit and loss statement (P&L statement) is a section self-employed individuals complete on their tax returns. More specifically, the profit and loss statement is included in Schedule C of Form 1040. It describes your gains and losses for the IRS in detail so your taxable income can be calculated. This form is required for any business that’s structured as a pass-through entity. It’s especially common for sole proprietorships, but LLCs and partnerships can also use them.

However, you might still need this type of financial statement outside the context of taxes. And you can create one on your own. Most often, entrepreneurs need to create a profit and loss statement for investors or lenders. It’s not uncommon for these groups to ask to see a statement before they’ll give you money.

Cash vs. Accrual Methods of Accounting

If you need to create a separate P&L statement or complete your Schedule C, you’ll need to determine what accounting method you’re using. There are two types: cash accounting and accrual accounting. With the cash method, you report transactions on your books every time money changes hands. For example, you’d report a debit for purchasing supplies and a credit for a customer payment. Cash accounting gives you a quick look at your simple profit total during a set period of time.

In contrast, if you use the accrual method, you report a transaction as soon as it exists — even if the money hasn’t changed hands yet. For example, you’d report an invoice on your books as soon as you created it. Operating expenses like your monthly internet bill and purchasing office supplies would also get recorded right away, even if you receive an invoice for them that you haven’t paid yet. In short, accrual accounting gives you a more comprehensive look at your business revenue in real time. 

The IRS requires you to identify which accounting method you’re using from the outset, as the choice will slightly affect your numbers. If you decide later that you want to change your method, you can (as long as you file the right form to notify them).

How to Make a Profit and Loss Statement

Even if you’re not an accountant, you can at least get started on a basic profit and loss statement. For starters, you can begin by calculating your revenue: all the money that you take in during a set time period. You’ll also need to calculate your cost of goods sold, which includes both the amount you sell an item for plus how much it costs to create and sell that good. You’ll also need to calculate other costs, such as your rent and utilities, your self-employment taxes, and more. There are also a good number of small business tax deductions you can make to legally reduce your tax burden.

Basically, by calculating your total revenue and subtracting all your business expenses, you can get an accurate net income statement.

That said, we highly recommend getting the help of a professional accountant if you have complicated aspects of your statement. This includes complicated calculations like amortization and depreciation. It’s best to let a CPA handle these calculations, as they’re tricky.

What are the benefits of making a profit and loss report?

There are several notable benefits to making a profit and loss statement. For starters, a good look at your financial health can guide your business decisions. You can see trends over time, such as how your monthly profit fluctuates throughout the year. You’ll see if your operational expenses are truly allowing you to have a profit margin. That knowledge in turn helps you make informed decisions about what you can afford, such as getting a business loan, hiring employees, or deciding to reduce your cost of sales.