Profit and Loss Statement
A profit and loss statement (P&L statement), commonly referred to as an income statement, is a financial statement that summarizes the revenues, costs, and expenses incurred by a company over a given period. It reveals whether the business earned a profit or experienced a loss during that period. The P&L statement is an essential document used by business owners, investors, and creditors to evaluate the company’s financial performance.
Types of Profit and Loss Statements
There are two types of profit and loss statements based on the method of accounting used:
- Cash Method: A cash-based P&L statement records income and expenses only when payments are received and made, regardless of when the sale was made or the service was performed.
- Accrual Method: An accrual-based P&L statement records income and expenses when they are earned or incurred, regardless of when the money was paid or received.
Structure of Profit and Loss Statement
Regardless of the method used, all P&L statements have a similar structure:
- Revenue: Revenue shows the total amount of income generated from sales, services, and other business operations.
- Cost of Goods Sold (COGS): COGS includes all the costs incurred to produce goods or services.
- Gross Profit: Gross Profit is the difference between the revenue and COGS.
- Operating Expenses: It includes all the expenses incurred while running a business, such as rent, utilities, salaries, marketing, etc.
- Operating Profit: Operating Profit is the difference between Gross Profit and Operating Expenses.
- Other Income or Expenses: It includes any income or loss that is not part of regular business operations, such as interest income, legal fees, one-time payments, etc.
- Net Profit/Loss: Net Profit/Loss is the final figure obtained by subtracting Other Income or Expenses from Operating Profit.
Example of Profit and Loss Statement
Here is an example of a P&L Statement for a fictitious coffee shop for the year 2021:
Cost of Goods Sold: $200,000
Gross Profit: $300,000
Operating Expenses: $150,000
Operating Profit: $150,000
Other Income or Expenses: $10,000 (Interest Income)
Net Profit: $160,000
In the above example, the coffee shop’s total revenue was $500,000, and its cost of goods sold was $200,000. After deducting COGS from revenue, we get Gross Profit, which is $300,000. Then, we subtract the Operating Expenses of $150,000 from Gross Profit, which gives us Operating Profit of $150,000. There was an additional income of $10,000 from interest earned, which was added to Operating Profit, resulting in a Net Profit of $160,000 for the year.
How To Analyze Profit and Loss Statement
The P&L statement provides a snapshot of a business’s revenues, expenses, and profits for a specific period. Here are some steps to analyze a P&L statement:
- Review Revenue: Start by reviewing the revenue section of the P&L statement. This section includes all the money earned by the business during the period in question. Analyze the revenue by comparing it to previous periods to identify any trends, and look for any changes in the revenue mix or pricing that could affect profitability.
- Evaluate Costs: The cost of goods sold (COGS) is the amount spent to produce or purchase goods sold during the period. This section also includes other expenses incurred directly related to sales, such as sales commissions. Analyze the COGS to determine whether the costs are reasonable and sustainable.
- Assess Operating Expenses: Operating expenses include all other expenses incurred by the business that are not directly related to sales, like rent, utilities, and salaries. Analyze operating expenses and look for any changes in the cost structure that could impact profitability.
- Calculate Gross Profit: The gross profit is calculated by subtracting the cost of goods sold from the revenue. This figure represents the profit made on each sale before accounting for operating expenses. Analyze the gross profit to determine whether it is sustainable and whether there are any changes in the gross profit margin.
- Review Net Income: The net income is the profit made by the business after deducting all expenses from revenue. Analyze the net income to determine whether there are any changes in the net income margin.
- Identify Trends: Analyze the P&L statement over multiple periods to identify any trends in revenue, costs, and profits. Look for any patterns that could affect future profitability.
- Benchmark Against Industry Standards: Compare the business’s financial performance to industry standards to identify strengths and weaknesses. Look for areas where the business is outperforming the industry and areas where it is lagging behind.