Whether you plan to apply for a loan or not, a profit and loss statement (P&L) is an important document to pile up. Why? It gives you a better understanding of your current finance and allows you to ramp up your cash flow management.
What is a Profit And Loss Statement Exactly?
The profit and loss statement also goes by a few other names e.g. an income statement, statement of operations, or earnings and expense statement. This document details revenue generated along with costs and expenses for a fixed period of time – a month, specific quarter or a fiscal year. Basically, you subtract your expenses from the revenue you’ve earned. Of course, it can be a bit more complex depending on your business model. But it’s worth an effort in any case as it gives you a clear picture of your company’s financial health.
When You Need a Profit And Loss Statement
If you own a small business, you will almost certainly need to create a profit and loss statement as part of tax season preparations. When filling a Schedule C form, you will be asked to submit a variation of this doc to the authorities.
There are other uses for a P&L statement. If you’re seeking investor funding, a profit and loss statement will provide potential bakers with information about your current financial situation and future outcomes. It’s also something you can use internally for auditing and financial planning throughout the year. Finally, if you want to get a loan from a traditional financial institution aka a bank, you will be requested to file this statement among the first things.
Essential Profit And Loss Statement Vocabulary
In order to create and understand your profit and loss statement, you’ll have to learn a few financial terms. Here they are:
Expenditures – This one is pretty easy on its face. These are the expenses that you pay out as part of doing business. Where it gets complicated is with the specific types of expenditures that you may not know about.
Revenue– If you think that revenue is your total sales dollars, you are partially correct. However, that’s not the only source of revenue. Tax refunds are revenue. So is the money you make from selling equipment or property. Imagine that you sell an old laser printer. The money you make from the sale is revenue, but you have to pay 30 dollars to ship the printer. That’s an expenditure. If you buy a replacement printer, that’s another expenditure. If you get a rebate on it, that would be counted as revenue.
Cost of Goods Sold– If you look at a profit and loss sample, you might see COGS. This is the cost of producing and selling your goods or services. Basically, you don’t make 100% profit on anything. You have to pay for shipping, materials, etc. Those costs get divided out into the number of items you sell, and are then subtracted from those sales numbers.
Gross Margin– This is revenue minus cost of goods sold.
Operating Expenditures – These are the expenses that don’t relate directly to the cost of selling your products and services. The money you spend on utilities, rent, training, wages, advertising, and telecommunications are all operating expenditures.
Depreciation– If you own equipment, computers, or company vehicles the value of these things depreciates over time. You are allowed to declare a loss on this depreciation at tax time.
EBITDA– This long acronym is earnings before interest, tax, depreciations amortization. This will give you a bit of information about your business’ profitability, but isn’t the most useful line item on your profit and loss statement.
Earnings Before Tax– If you subtract the cost of goods sold, operating expenses, depreciation, and EBITDA from your total revenue, you get your EBT number. This is the number you can use to determine your financial health. You can also use it to compare your company’s performance with others.
Profit is the bottom line. It’s the result of your subtracting every expense you have for a given of time from the total revenue for the same time period. If this is a positive number, you are in good shape.
How to Create Your Profit And Loss Statement: Key Steps
Once you understand the vocabulary involved, and the purpose of a profit and loss statement, you are ready to create your own. This is an important document, but it’s surprisingly easy to create.
Your Financials Package
If you have a good accounting software package, this process is going to be infinitely easier for you. In some cases, you may be able to simply produce the report through the dashboard the package has provided for you. Even if the package you choose doesn’t have that capability, the information that is collected and stored will be useful to you when you create the report yourself. Finally, a bookkeeper or accountant can use the information from your accounting package to verify the accuracy of your P&L statement.
A good financial or accounting package for your business will cost money. However, the ease and accuracy that results can be well worth the expense.
If you need to prepare your profit and loss statement without the benefit of an accounting software package, here are the next steps you will have to take.
1. Obtain Your Business’s Revenue For The Relevant Period of Time
These are the sales you have generated for the time period that is in question. In most cases this will be for a single quarter, or the amount accumulated from all of the quarters in a fiscal year.
2. Detail All of Your Business’s Expenses For That Same Period of Time
Here you don’t just want to determine the amount of money your business spent, you’ll want to break those expenses down. This will give you more insight into your financial situation. Your expenses will generally fall into cost of goods sold and operating expenses.
3. Subtract The Total of Your Expenses From The Total Revenue
This is where you calculate your EBITDA. You do this by simply subtracting total expenses from revenue.
4. Add Taxes, Interest, Depreciation, And Amortization And Subtract From EBITDA
These are the part of your profit and loss statement that are the most complicated. To get a better understanding of these things, you should do a bit of reading.
5. Determine Whether or Not You Have Earned a Profit For That Period or A Loss
Once you have completed step 4, you will have a clear picture of whether or not you operated at a profit, or took on a loss during that period of time. Even better, if your report is detailed and correct, you will be able to identify some of the sources of your loss or profitability.
Remember that profit and loss statements are often required by law for tax reporting purposes. You’ll also be expected to deliver one if you are applying for a small business loan. Even if you don’t need one for those purposes, it’s still an important report on your financial situation.
Once you know how to create and read your profit and loss statement, you increase the likelihood of your being able to turn a profit with your business. If you generate profit and loss statements frequently, it’s as if you’ve conducted a brief financial checkup. You can identify potentially damaging financial issues in the long run, but deal with them in the short term.
Profit and loss statements are particularly useful for solo entrepreneurs, small business owners, and freelancers. They are easy enough to create and read. It doesn’t take much financial expertise to understand one, and then act on the results.
Common Profit And Loss Statement Mistakes To Avoid
If you make a mistake on your profit and loss statement, the consequences can be pretty serious. Obviously, you don’t want to submit inaccurate information to the IRS. That can create a whole host of headaches for you to deal with.
Lenders and investors may not penalize you or subject you to audits, but it will still look bad if the report you provide them is incomplete or inaccurate. The common profit and loss statements mistakes to account for are as follows:
- Listing items from the wrong period of time in your report. There will likely be figures that you have to include in your report that start before the end of one reporting period, but end after the beginning of the next. This is to be expected, but you have to determine where that number will reported, then you have to be consistent about it going forward.
- Missing items that should be included in your report. This is where good record keeping is so important. If you have to chase down receipts, and have financial records stored across different spreadsheets and files, you’re going to be more likely to miss things.
- Calculation errors that you make when totaling the different amounts that are on your report.
So be sure to run all your numbers once again before filling that document to anyone. And don’t be penny-pitching when it comes to enlisting professional help with accounting. Those money would be well-spent as long as you receive an accurate document, detailing all the nitty-gritty of your business operations and financial health.
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