As a small business owner, you’re often preoccupied with all the things that go into running your Orange County business – the daily logistics, managing employee workflow, paying the bills, bringing in more customers… making a profit.
Let’s focus on that last one, shall we? Good.
Profits are the lifeblood.
And the P&L is probably the most crucial financial statement in growing your Orange County business.
But too many people don’t really look at them or even know what to do with them.
So today, I’m here to help.
If you want to talk about how you can use these P/L report thingies better – or perhaps just how you can chart a financial forward path through times that might currently look a little bleak … this is what we do:
So let’s get into the details. Firstly, how to BUILD an effective profit and loss statement – because that’s more than half the battle…
James D Anderson CPA’s Guide to the Profit and Loss Statement
“I made my money the old-fashioned way. I was very nice to a wealthy relative right before he died.” – Malcolm Forbes
Your Orange County small business needs a lot of documents, and one of the most important is your profit and loss statement (P&L).
It’s called other names – income statement, a statement of profit and loss, income and expense statement, earnings statement, statement of financial results – but it always shows whether your company made a profit in a reported time period. Sure sounds like something your small business shouldn’t be without.
What’s on one? Here’s an overview.
Why you need a P&L
Your P&L basically shows your revenue minus expenses and helps make clear how your business turns revenue into profits.
Private companies use their P&L for internal management and decisions. Public companies must include a P&L in financial statements for public disclosure. Outside your company, creditors and investors will consult your P&L to estimate risk, and we’ll use your P&L to figure out your taxes and other information for the Internal Revenue Service.
Plainly put, the Small Business Administration says the P&L is the best tool for knowing if your business is profitable.
What to include
As we said, the formula for a P&L starts with your sales minus the costs of your goods/services sold to find your gross profit. Take away your overhead and you have your net profit.
The parts are:
- Your income or revenue from selling your product or service during a certain period.
- Total costs for items in your inventory that your customers buy. This can comprise the cost of purchasing the items, shipping, manufacturing, and so on. For services, this can include labor, materials used and transportation, and other incidentals.
- Your sales less the costs, aka gross profit.
- Overhead associated with your operation, such as rent or utilities.
- Gross profit minus your overhead, or net profit.
Typically, a P&L can run from a few to several pages depending on how complicated your business is. How do you start?
Pick a timeframe. Monthly (usually they’re no more frequent than this), quarterly or yearly are the usual periods. Longer timeframes can show more information you can act on, but you don’t want overload from decades of data, either.
List your revenue for the period. In this top line, break down the totals by month (include income sources by month) and, if applicable, account for discounts and returns. Also, note whether sales are recorded when an order is placed (accrual accounting) or later when you receive payment.
Calculate your expenses. Separate such direct costs as goods and operating expenses. Costs of goods do not include selling and administrative costs (as you might have with services); those you list later.
Many small businesses compute the cost of goods sold directly by taking the value of inventory at the beginning of the period, adding the value of goods purchased during the accounting period, and then subtracting the value of the inventory on hand at the end of the period. (This gets more complicated if you’re a manufacturer – check with us.)
Determine your gross profit. Subtract your direct costs from your revenue. Here’s also where you enter your selling expenses and general and administrative expenses such as rent, utilities, telephone, travel, and supplies. Repairs and improvement expenses can also be deducted, but only for expenses to maintain property or equipment. (Major overhauls of equipment or maintenance that extend the life of the asset must be capitalized.)
This part is also known as your gross margin, and it’s usually given as a percentage of your revenue.
Other income and other expenses. Other income includes interest, dividends, non-categorized sales, rents, gains from asset sales, and so on. Other expenses can be unexpected losses unrelated to your normal business. Add both to your income and expenses categories.
Subtract your total expenses from gross profit. A positive number means you’re making money. A negative number means, with luck, that you can at least pinpoint what’s hurting your company.
Also, you can use one of two accounting methods to create your P&L. The simple single-step method means you just total revenue and subtract expenses. With the multi-step method, you deduct operating expenses from revenue, showing your operating income. You then add that to the net of non-operating revenues, non-operating expenses, and investment gains or losses to get your pre-tax income. Deduct taxes and you have your net income. (We can help with this.)
Models to work from
You can assemble a simple P&L using Excel and Google Sheets, which offer templates. Templates are also on financial websites such as U.S. Legal Forms or come with such software as QuickBooks or Microsoft 365.
These, paired with what you’ve learned, should get you started on this indispensable business document. Next, we’ll look at how to analyze a P&L.
If you want to get more into the details of your profit and loss statement or any other financial statement, we’re here and ready to serve you:
In your corner,
James D Anderson CPA