Profit & Loss Statement: Ultimate Guide for Small Business Owners

Profit & Loss Statement: Ultimate Guide for Small Business Owners
There are three financial documents that are extremely important for both small businesses and large corporations. The three documents are: These documents help business leaders and investors evaluate the financial health of a business. No one document is more important than another, but the profit and loss statement is undoubtedly the most anticipated and scrutinized. If you’re new to the business world, you should definitely learn what a profit and loss statement entails. Have a specific question about profit and loss statements? Use the links below to navigate throughout our guide, or read end-to-end for a comprehensive overview.

What’s a profit and loss statement?

A profit and loss statement is sometimes called an “Income Statement,” “Revenue Statement,” “Operating Statement,” or “Statement of Financial Performance.” These are all different terms for the same thing. But what does the profit and loss statement actually do? The profit and loss statement shows a business’s revenue, expenses, and net income over a period of time. Usually, the statement is made quarterly and annually, but some companies also prepare it monthly. There’s no single correct template for a profit and loss statement, but we’ll provide a generalized one down below. Know that the length of the document is dependent on the size of the company. Small businesses are bound to have shorter statements, while larger companies will have longer ones.

Why is a profit and loss statement Important?

profit and loss statements are important because they help business leaders determine if a company is trending toward profitability or losses. Because the statement thoroughly lays out income and expenses, business owners can easily identify where changes need to be made to boost revenues or cut costs. If you own a small business, a profit and loss statement can answer a few important questions for you:
  • Can I afford to hire a new employee?
  • Can I afford to move to a bigger office?
  • How should I plan my taxes?
  • Is my current growth strategy effective?
Although the statement can help you in long-term business planning, it can also help you make practical decisions in the short-term. If you’re seeking financing from investors, you may need to show them a profit and loss statement to prove your company is or can be profitable. Corporations are required to provide profit and loss statements to the public. If you’re going to prepare an accurate profit and loss statement, it’s important that you have meticulous accounting practices at your business.

Section by Section Guide

Nowadays, many small businesses use bookkeeping services to prepare their profit and loss statements. But you should still know how to read and interpret each section of the document. Let’s review the profit and loss statement section by section.

1. Revenue

This one’s easy. The Revenue section details the total income that your company makes. It lists all the revenue generated by:
  • Sales
  • Money received by selling assets
  • Money received from tax refund
Depending on what your business does, you might subdivide this section into “Online Sales” and “In-Store Sales.” It’s always better to be specific and state where all sales were generated, although that information will also be available in your Cash Flow Statement. Remember that quarterly statements will only report revenue gained during that particular financial quarter. Indicator: If your business profitability is low, refer to this section and determine whether or not your company needs to generate more sales.

2. Cost of Goods Sold (COGS)

If your business sells a product, chances are the product isn’t free to manufacture. Let’s say, for example, that your company manufactures fidget spinners. For every fidget spinner you produce, you have to pay for the materials, labor, and machinery to make it. You manufacture them in large batches, which saves money, and ultimately you pay about 30 cents for each one. The Costs of Goods Sold (COGS) section details these types of manufacturing expenses. They’re important to list because they detract a small portion from the revenue you gained by selling your product. COGS is not exclusive to retail sales. If you own a restaurant, you probably have to pay for the food that you cook—what you pay for ingredients would be listed in the COGS section.

3. Gross Profit

To calculate your company’s gross profit, subtract COGS from Revenue:
  • Revenue – COGS = Gross Profit
Gross profit is important because it’s a more accurate statement of your company’s revenue, since it accounts for product expenses. Indicator: If your business profitability is low, refer to this section to see if your product costs are too high.

4. Operating Expenses (OPEX)

The Operating Expenses (OPEX) section totals the costs of running your business that aren’t related to COGS. Operating expenses include:
  • Payroll
  • Travel
  • Training
  • Building Leases
  • Utilities
  • Equipment Purchase
  • Hardware and Software
  • Advertising
  • Cell Phone and Internet Service
On a real profit and loss statement, each of these operating expenses would have their own sub-category. A larger company is more likely to have a longer list of operating expenses than a small business. However, this might be one of the most important sections for a small business. Small businesses are in a constant struggle to minimize operating expenses, and so this section can be highly revealing.

5. Depreciation

Your company might own a variety of assets, like a building, vehicles, or equipment. Most assets generally depreciate over time. In the Depreciation section, you state the loss in value of all company assets. This section is usually only included on annual profit and loss statements. Depreciation can be important for taxes—but how do you calculate it? If you want to maximize your tax savings, we highly recommend using a small business tax service. Taxes are a complicated field and can be a major burden on smaller companies, but tax professionals will do the heavy lifting for you.

6. Earnings Before Interest and Tax (EBIT)

Calculate your Earnings Before Interest and Tax (EBIT) by subtracting Operating Expenses from Gross Profit:
  • Gross Profit – Operating Expenses = Earnings Before Interest and Tax
You might be wondering why a profit and loss statement distinguishes between Revenue, Gross Profit, and EBIT. Indicator: If your business profitability is low, refer to this section to and see if your operating expenses are too high. If this is the case, you might look into how you can cut down on expenses such as inventory, staffing, and utility costs in order to increase your profit margins.

7. Earnings Before Tax (EBT)

Calculate your Earnings Before Tax (EBT) by subtracting COGS, OPEX, interest, and depreciation from your revenue:
  • Revenue – COGS – OPEX – Interest – Depreciation = Earnings Before Tax
You might be wondering what “interest” refers to. Interest refers to any financing your company receives that it must pay off. You might have sought financing to remodel your store, or to construct a new building, or to buy a company vehicle. Whatever the case, you’ll want to account for debt payments in this section. Earnings Before Tax is usually a great indicator of business performance. In this section, you’ll be able to see most of your company’s revenue and expenses, minus taxes.

8. Earnings Available for Common Shareholders

This section shows your company’s total profit after taxes (if you’re going to be filing your own taxes, be sure to take advantage of our small business tax form library). If your business has investors, this is the money that can be used to pay out dividends to shareholders. You don’t need to include this section if your business doesn’t have investors.

9. Owner’s Draw

This section states the business owner’s salary. This salary comes out of company revenues.

10. Net Income

At last, we reach the Net Income section. This is the proverbial “bottom line” that’s talked about so often in business—it’s literally the bottom line of the profit and loss statement, and it’s inarguably the most important line. Net Income states the total quarterly or annual profit of the company, having accounted for expenses, taxes, and all total revenue. Ideally, you want your Net Income to be as high as possible.

Sample Template

profit loss value

Analyzing Your Profit and Loss Statement

After you’ve prepared your profit and loss statement, you should analyze it and use it to create new business strategies or change existing ones.

What if my company made money?

Even if your company made a profit, you should still analyze the profit and loss statement. Your goal as a business leader is to do what you can to boost your company’s profitability. You might view the Operating Expenses section and find areas where you can easily cut back costs. Or maybe you’ll realize that your company isn’t making the most out of its tax savings, and you can work closely with tax professionals to prepare for tax season. If your company made money, you’ll also have to decide what to do with the profits. Some of your options include:
  • Re-investing the money
  • Saving the money (“rainy day” funds)
  • Boosting salaries or granting bonuses
What you choose to do with your profits is up to you. May you have such troubles.

What if my company made less money than last year?

In the corporate world, corporations are under pressure to make greater and greater profits every year. Sometimes investors panic when a company doesn’t make as much money as it did the prior year. But just because your company loses profit from year-to-year, doesn’t mean your business is doing poorly. Let’s say your business makes $20,000 in 2018, and then it makes $18,000 in 2019. Sure, you were $2,000 less profitable, but $18,000 is still a huge and satisfactory profit margin. It’s possible that the loss in profit occurred due to uncontrollable economic circumstances, like recessions or trade wars. However, you should be wary about downward trends over a subsequent number of years. For example, if your net income falls from $10,000 in 2016 to $3,000 in 2019, you might need to make some major changes in your business. You can use the profit and loss statement to determine where your company is lacking revenue, or to determine where it’s spending too much. profit loss graph

What if my company lost money?

Don’t panic if your company lost money—even large, successful corporations take losses during some years. The point of preparing a profit and loss statement is to gain a more detailed understanding of what’s keeping your business from being profitable. It might be that you need to generate more sales, or it could be that your operating expenses are too high. Whatever it is, remember that a profit and loss statement is a tool and not necessarily a death sentence. If you’re a new business, it might even take a year or more to gain cash flow and profit.

Bookkeeping and Accounting Services Tailored to Your Small Business

If all of this number-crunching is making your head spin, enlist the help of a bookkeeping and accounting professional. From initial setup to regular reporting, our team can tackle the nuances of profit and loss statements, budgets, and more—giving you more time to focus on growing your business.