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.
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.
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).
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.
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.
Starting and managing a business can feel overwhelming, but you don’t have to go it alone. Whether you need help opening a business bank account or even starting your first LLC, we can help. We also offer a streamlined Money app that can help you track your income and expenses to make tax time easier.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
At a minimum, an independent contractor will need a profit and loss statement at tax time to be able to calculate their taxable income. However, an independent contractor might create a separate profit and loss statement for a meeting with a bank for a loan to buy new equipment, or something similar.
Generally, every business will need a profit and loss statement at some point — if only just for tax season. This requirement will apply to any business type, including sole proprietors. There are, of course, other reasons you might need one. Even if you don’t need one to give to an investor, a P&L statement can help you assess your present and future business performance.
Self-employed individuals will need to file a profit and loss statement, but they’ll do so on Schedule C of Form 1040 when they file their taxes. There are other uses, too, such as working with new investors.
Dealing with accounting can feel overwhelming as a small business owner, especially if you don’t have a business degree. There are so many terms: balance sheets, cash flow statements, profit margins, and more. As an entrepreneur, your time is money. And if it would save you more time and stress to hire someone else to manage your books, it may be well worth the expense.
That said, if your books are pretty simple and you can finish them in a manageable time frame, you might be able to handle them on your own. Business accounting software like our Money app can be a helpful tool.
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