What Is a Profit and Loss Statement and How Do You Make One?

Profit and loss statement: Definition and purpose

A profit and loss statement is a financial document that summarizes a business' revenues, costs, and expenses over a specific period of time (generally a reporting period such as a quarter or a year). This summary of the company’s gains and losses helps decision makers to better understand the overall profitability and financial performance of the business.

Why businesses need a profit and loss statement

Profit and loss statements are critical for a number of reasons. Company stakeholders may use it to assess the operational efficiency of the business, which can be useful when making strategy and budgeting decisions or identifying areas where costs can be cut and revenue enhanced.

P&L statements also have an important role to play when it comes to compliance. Publicly traded companies are actually required to prepare and file a profit and loss statement with the U.S. Securities and Exchange Commission (SEC) since they provide critical information to investors and regulatory bodies. If you’re a sole proprietor, the IRS also requires you to file a profit and loss statement in the form of a Schedule C (Form 1040).

But even if your business isn’t required to file a P&L statement, it can be a good idea to have one prepared if you plan to apply for loans or other financing, as creditors will likely need to have a clear sense of your company’s financial performance before deciding whether to extend your credit, and how much.

What’s in a profit and loss statement?

Detailed profit and loss statements will provide you with several income-related figures, each of which will be calculated and placed on its own line.

• Revenue (sales): The total amount the business earned from sales of its goods or services.
• Cost of goods sold (COGS): The total amount the company spent to produce the goods or services it provides.
• Gross profit: The amount of profit left over after you subtract COGS from total revenue.
• Operating expenses: Total costs incurred performing activities essential to the business’ operation, which can include everything from rent and utilities to employees’ salaries.
• Operating profit: Also known as operating income or earnings before interest and taxes (EBIT), this is the amount of profit left over after subtracting operating expenses from gross profit.
• Other income and expenses: Any other income or costs incurred that don’t directly relate to the operation of the business. An example of a non-operational cost is interest payments paid on a loan.
• Net profit (net income): Final profit after all expenses and revenues are tallied.

Single-step vs. multi-step profit and loss statements: What’s the difference?

Profit and loss statements can be simple or more detailed, depending on how in-depth you want to go in analyzing your company’s overall financial performance.

With a basic, single-step profit and loss statement, you will be able to see the business' net income—also commonly referred to as its bottom line—at a glance. If you’re drafting a P&L statement solely for accounting purposes or to get a general idea of the company’s performance, this simplified approach may be all you need. However, this may not be enough to satisfy investors or creditors who will want more detailed information on where your business is spending money and why.

Multi-step profit and loss statements may be preferred, both for publicly traded companies, which provide them for compliance purposes, and for anyone who wants a better understanding of the company’s financial health and areas for improvement. While it can be more timely to prepare a multi-step P&L statement, the financial insights it provides can prove invaluable since it gives a more detailed look at gross, operating, and net margins and allows stakeholders to make more informed business decisions.

How to make a profit and loss statement

Creating a profit and loss statement should be relatively simple if you’ve kept accurate, ongoing financial records of your business’ gains and losses. If you’re compiling your P&L statement manually, rather than using accounting software, you’ll need to follow some version of the steps below.

• Step 1: Gather financial data. Collect all financial records, including sales records, expense receipts, and other relevant documents for the particular period in question.
• Step 2: Calculate total revenue. Add all income generated from sales or services for the reporting period.
• Step 3: Determine cost of goods sold. Add up all the direct costs related to the production of goods or services sold.
• Step 4: Compute gross profit. Subtract costs of goods sold from total revenue to get your gross profit.
• Step 5: Subtract operating expenses. List and sum all operating expenses, then subtract from gross profit to determine your operating profit.
• Step 6: Account for other income and expenses. Include any additional income or expenses not related to core operations.
• Step 7: Calculate net profit. Subtract taxes and interest expenses from operating profit, and add any other income to get your final net profit sum.

Analyzing a profit and loss statement

How you analyze your company’s profit and loss statement will largely depend on your goals for doing so in the first place. If all you hope to determine is whether your business is profitable or not, a simple glance at your net profit can help you arrive at that conclusion quickly and with little effort.

If, however, you’re looking to scrutinize your operational practices to discover ways you can do business more efficiently and increase your profit margins, you’ll want to delve deeper into each line item of your P&L statement to see if you can identify areas of waste, while also analyzing patterns or growth or loss to account for things like seasonality or market fluctuations.

It also will be informative to compare profit and loss statements from previous periods, in order to see how revenues and expenses may be changing. If your revenues are growing—but not as fast as your expenses are growing—you can identify steps to take to improve your business' financial position.

Profit and loss statement example

To better understand what a profit and loss statement looks like, consider the following example for a fictional small business with a sole proprietor. In this fictional example, our business owner is a dog walker whose costs and operating expenses include things like leashes, treats, and waste bags, plus transportation costs incurred while driving to her clients’ homes. She also spends a small amount of money each quarter to print business cards and flyers to advertise her business and counts these as non-operating expenses.