Whether your business is losing money or making money, every business needs to keep the profit and loss in check. A profit and loss statement for small businesses is a tool to assess expenses, earnings, sales, and income. It lets you decide if the business is profitable or will be profitable and growing or is it losing money and you need to change paths.
You might want to invest in a business but don’t know how to read a profit and loss statement. Or you can be an entrepreneur who just started a new business and want to learn more about the financial statements for P&L management.
Whatever the case, every small owner needs to learn to make a profit and loss statement for small businesses.
What Is A P&L Statement?
So, let’s get to what is P&L statement?
A P&L statement is a profit and loss statement also known as an income statement or statement of profit, that helps you keep track of your financial progress. The profit and loss statement for small businesses outlines the business’s income and expenses over a fixed period.
The financial statement is like a snapshot of your business’s revenue and expenses over a period. Usually, the P&L statement is prepared annually or quarterly but it can be prepared monthly, weekly, and more frequently.
Balance Sheet Vs Profit And Loss Statement
Let’s discuss the balance sheet vs profit and loss statement.
If you are confused about what is P&L statement? A P&L statement is a financial statement that helps you understand how your business is performing. On the other hand, a balance sheet vs profit and loss statement shows the position of the business. It shows the total assets, liabilities, and owner’s equity. Balance sheets are usually prepared Yearly or quarterly as the items of the balance sheet don’t change a lot.
The balance sheet shows if a business is too leveraged. However, the P&L statement is one of the most important statements because it checks a business’s ability to make a profit. Preparing a P&L statement can be straightforward and with some practice, anyone can make P&L statements for small businesses.
In balance sheet vs profit and loss statement, both financial statements are crucial for understanding a business. As, the balance sheet shows the financial position of the business and, the profit and loss statement shows the performance of the business.
There are two ways to make P&L statements. You can make them manually on register or they can be made automatically on an accounting system. The business accounting systems can make P&L statements with the click of a button. It can track revenues, expenses, assets, and other key numbers as they occur and generate financial statements automatically that can be viewed within the system or printed on paper.
When Should You Make P&L Statements?
P&L statements are typically prepared on a monthly, quarterly, or annual basis. You might also have to submit P&L statements for small businesses when applying for a small business loan as they show your profit and loss history.
When companies seek investors or want to sell businesses, the interested parties want to see the profit and loss statements from previous years. The direction in which a business is moving is depicted through the profit. Even the tax laws require business owners to submit their P&L statements for small businesses.
How To Read A Profit And Loss Statement?
Revenues and expenses are reviewed and comparing the same amounts from different periods side by side for P&L management. For example, to check how the sales have increased from 2019-2021, looking at the yearly sales amount from 2019, 2020, and 2021, investors track how the sales have increased or decreased over the last 3 years.
Depending on which accounting method is used, whether the company records its reports on a cash basis or accrual basis. The cash basis refers to the reporting of income and expenses when the income is received, and the expenses are paid. Accrual basis is recording an expense and income when a service is taken, and the goods or services are sold regardless of payment received or not.
The accounting methods used can affect the items of a profit and loss statement for small businesses. To understand each item on a balance sheet, we’ll break down the profit and loss statement for small businesses into line-by-line entries.
You should know some accounting headers when looking at how to read a profit and loss statement, so let’s start with that.
Items Of A Profit And Loss Statement For Small Businesses
The two most important components of what is P&L statement are the income and expenses within the same period. These components are discussed in detail below:
Revenue
Revenue is the first item that is reported on a profit and loss statement for small businesses. It includes all the incomes a business has earned in a fixed period. For example, if a company’s major revenue comes from selling motorbikes, the good sold is its main income. However, if the company has rented out a part of its building, the rent is also revenue that will be reported on the P&L statement under the header revenue.
The operating revenue of a business can also be called sales, gross receipts, fees, or any other term. If you are confused and can’t find any of the above-given names, always look for the topmost item in the profit and loss statement for small businesses, it is the revenue. It may have a different name but it always refers to the revenue of the firm.
Cost Of Goods Sold (COGS)
In a profit and loss statement for small businesses, the cost of goods sold is the cost of inventory and materials used in making a product or delivering a service. The cost of goods sold is to be subtracted from revenue to arrive at the gross profit. If a company spends $20 on manufacturing a product and sells it for $100, the gross profit is $80.
Expenses
The expense portion of a profit and loss statement for small businesses shows the expenditure of a business, the daily financial activities of the organization. This may include day-to-day expenses like delivery charges, rent, utility bills, and others. Expenses are further categorized into 2 major types. Operating expenses and non-operating expenses.
Operating expenses are further divided into three categories: Admin expenses, Marketing expenses, and Other Expenses in a Trading business. For a manufacturing business, the expenses are divided into materials, labor, and overhead costs.
Some businesses also include asset depreciation as an expense on their profit and loss statement for small businesses. Purchases such as office equipment and computers are capitalized as an asset and written-off over the useful life of the asset. For instance, a computer system was bought for $1000. If its value is to be written off over the next 5 years. The value of the computer should be depreciated by adding the 20% cost of the computer to the expense section every year. Firms lower their taxes by showing such expenses on their P&L statements.
Expenses such as interest and taxes are broken out separately under the non-operating expenses to keep the P&L statement simple and organized.
Gross Profit
Gross profit refers to the difference in revenue and cost of goods sold. If an item is sold for $1000, and the cost of goods sold is $300, the gross profit will be $700.
If the company does not sell any goods and is a service business, the gross receipts or revenue will become the gross profit because there will be no inventory consequently no cost of goods sold to be subtracted.
Net Profit Or Loss
The net profit or loss is the company’s income that is obtained by subtracting all the other expenses including taxes, depreciation, and amortization. If these expenses are not subtracted, the income is called earnings before interest, taxes, depreciation, and amortization is often written as EBITDA.
Some companies end their P&L statements at EBITDA so that it is easy for investors to compare this item to other companies in different industries.
How To Do A Statement Analysis Of A Profit And Loss Statement For Small Businesses
There are three major types of analysis to have a glance at how the company is performing. Delving deeper can reveal much more about the company but to check the performance of a company especially when comparing similar companies, this analysis can give you an idea of how the trends of each P&L statement item.
If you already know how to read a P&L statement, financial statement analysis is the next step. So, let’s dive into what is P&L statement analysis.
The different types of analysis can show if a company is making money or losing money. Analysis can create a comparative profit and loss statement for small businesses that helps you see its performance in terms of either one component such as sales or over the years.
Here are 3 major ways to analyze a profit and loss statement for small businesses:
Horizontal Analysis
Horizontal analysis is often referred to as a series analysis as it looks as it is changing over time within a particular line item. For instance, if you are looking at the revenue over the five years. The horizontal analysis takes one year as a base year and then turns all the other years into percentage changes in the base year. This helps you see which year the revenue was greater or lesser than the base year’s revenue.
It helps the investors or analysts see patterns such as cyclical occurrences. It helps investors detect the red flags. For example, an investor might detect an unstable COGS that might diminish the profit if it climbs even higher in the future.
So, to review the company’s financial statements over multiple periods, the investors or analysts use horizontal analysis. As the percentage growth is easy to comprehend instead of large figures.
The formula for horizontal analysis is dividing the difference between the amount and comparing it to the comparison year or base year. The below-given formula calculates the percentage for each year:
Horizontal analysis formula = {(Comparison year amount – Base year amount) / Base year amount} X 100
Vertical Analysis
Usually, the vertical analysis is called common-size analysis as it determines the size of expense items to the company’s revenue. Vertical analysis is a method of financial statement analysis where each line item is calculated to get a percentage of a base year within the statement.
It compares items, for example how much the company is spending on marketing or research relative to its revenue? And is this trend increasing or decreasing over time? This gives investors valuable insights into how well the decisions are made in the company. Just like horizontal analysis, the relationship between two items in the same financial period’s financial statement is identified by expressing all the amounts as a percentage of the figure.
The formula to calculate each item’s percentage is:
Vertical analysis formula = (Statement line item / Total base figure) X 100.
Ratio Analysis
Ratio analysis is a cornerstone in equity analysis, it is a quantitative method used to gain insights into a company’s liquidity, operational efficiency, and profitability. The ratio analysis calculates ratios using a balance sheet and income statement.
There are 5 main categories of ratios:
- Liquidity
- Solvency
- Profitability
- Efficiency
- Coverage
These ratios give investors insights into how one balance sheet item when compared to another presents a different story.
Bottom Line
Small businesses are focused on gaining a clear view of how their business is doing and what is the condition of P&L management. What needs to be improved and what is going according to the plan.
A profit and loss statement for small businesses can give the business owner complete control over finances, P&L management, and profitability. To maintain and review the business’s revenue, expenses and profits, every small business should prepare a profit and loss statement for small businesses regularly. We hope this article has helped you know how to read a P&L statement.
