- A profit and loss (P&L) is an indicator of company health.
- The P&L is one of the primary documents you'll need to provide to acquire financing.
- It allows banks and investors to see your business's total income, debt load and financial stability.
- Anyone can create a P&L statement with some training and practice.
If you're thinking of starting a business or seeking financing for your venture, you're probably worried about all the bookkeeping involved. The good news is that it's not as hard as you might think.
One item you will need to familiarize yourself with is a profit and loss (or P&L) statement. A P&L statement is a document that compares the total revenue for a business against its debt and expenses. Essentially, all of the company's expenses are subtracted from the income. Other names for a P&L statement include the income statement, earnings statement, revenue statement, operating statement, statement of operations and statement of financial performance.
A P&L statement is an indicator of the financial health of your company. Some P&L statements are very simple; others are extremely complex.
Before we dive into the basics of understanding, creating and using a P&L statement, here is a primer on a few basic terms you will need to know. First, "net income" means the income your company makes after all of its expenses are deducted. If your P&L statement lists a low net income because the expenses are high, banks will not want to extend financing to you.
"Operating income" is another key term. It is the income you derive from the primary business and primary services. In the case of a hair salon, operating income are proceeds from the sales of providing services (i.e., haircuts, hair color, selling products, etc.); it isn't the income you gain from side activities.
How do you analyze a P&L statement?
Once you understand the basic terms, you can analyze other P&L statements to ascertain the financial condition of that company.
When analyzing a P& L statement, pay close attention to net income, operating income, and the expenses and depreciation for the business. You may have heard the term "bottom line," which in everyday conversation, means the final conclusion or decision. However, with a P&L statement, the bottom line is the final determination regarding a company's financial health.
Why is preparing a P&L statement important?
P&L statements are important, because many companies are required by law or association membership to complete them. A P&L statement also helps a company's management team (including its board of directors) to understand the business's net income, which may be helpful in decision-making processes. For example, a business owner may consider whether his or her company is bringing in enough of a profit to justify renovating their building or expanding in other ways.
You will also need to furnish a P&L if you are applying for a small business loan or if you're seeking funding from investors. Lenders and investors will evaluate your net income and operating income against the expenses, debts, and taxes to ensure your business is viable and worth providing financial assistance to.
What are the components of a P&L statement?
Most P&L statements are similar in appearance. In the first section, the cost of goods sold is subtracted from revenue – this represents gross profit. In the next section, operating expenses are deducted from the gross profit, leaving the operating profit. (These are earnings before interest and taxes.) Then, nonoperating revenues and expenses are subtracted from the total, leaving the total profit or loss.
A P&L is typically prepared around tax time, but it may be used in a few other instances, such as to inform the business owner, employees, and shareholders of a company's performance, or it can be used as proof of income if the business is sold.
How do you complete a P&L statement?
Though a P&L statement is one of the more complicated bookkeeping practices of a business, with some knowledge and practice, you can do it. However, many business owners hire a bookkeeper or an accountant to complete this task.
Understanding the basics helps. There needs to be a section on net income and operating income, a section on expenses and debts, a section on taxes and lease payments – which can also include association and membership fees to run the business – and a final section that includes the bottom line and other indicators of financial solvency.
Who prepares a P&L statement?
As mentioned previously, the decision about who prepares your P&L statement comes down to whether you have the time, inclination, aptitude and resources to prepare one internally.
If you are more focused on other aspects of your business, it is perfectly acceptable to hire an outside expert to create a P&L statement for your business. A downside of hiring this task out, though, is that you may not understand the inner workings of your business.
If you do hire out the task of creating a P&L statement, talk with your bookkeeper or accountant about the final statement, why the net income is at a certain level, your expenses and what, if any, steps you can take to run the company more efficiently.
What is the difference between a P&L statement and a statement of revenue?
Technically, a statement of revenue could be a section of your P&L statement. It includes only the income data for a company. It can provide insight for lenders and investors as to the income sources for the business. Often, this statement is used as an early indicator of whether the company is generating revenue in the marketplace. Sometimes, a statement of revenue includes expenses, but it typically does not include debt loads, a breakdown between net income and operating income, and it isn't as detailed in terms of overall financial data. Many banks and investors will eventually want to see a complete P&L statement.