Running a business is like a money game. Do you want find out how to win the game? To win, you must have profits at the end of any cycle. The Profit and Loss statement (P&L) summarizes moves you make during the game. The balance sheet features your score, which results from your moves. Each time you make a move, you make an important decision that could potentially take your business to the level. To win long-term, you need to accumulate profits on an ongoing basis.
What Is a Profit and Loss Statement?
Some people call the P&L statement an operating statement, or the income statement. But ‘income/outgo statement’ might be more descriptive, because the P&L statement shows you where your money is going day by day.
When you make a sale (earning revenue), you must deduct three things: the cost of what you sold, your business expenses (operating expenses), and your interest charges and taxes. The amount remaining is yours to use to expand your business.
Remember, revenues are different from profits. Some people think revenues are theirs to play with, but that’s not quite the case. That’s where creating a profit and loss statement comes in handy, as it gives you better insight into what’s hovering below the surface and helps you prepare for potential surprises.
Here’s how the P&L works. Your Cost of Goods Sold (COGS) varies with how many items you sold (the inventory you bought, the packaging, the delivery charges, and other costs that vary with volume). Subtract them from your revenue to find your gross profit (how much you have left) to manage your ongoing operations.
- Revenues (gross sales), minus
- Cost of goods sold (what the sale cost you), equals
- Gross profit (money from which you pay your operating expenses)
Whether you sell anything or not, there are operating expenses you have to pay. Your rent, phone, heat, parking, gas, and advertising are examples of the usual costs of operating your business. Deduct these costs, plus taxes, from your gross profit.
- Gross profit, minus
- Operating expenses and taxes, equals
- Net profit or net loss
When you show profits at the end of the period, you have choices: should you buy equipment, pay off loans, take dividends, or keep the cash on hand for later? If it’s a loss, you’ll want to sharpen your planning pencil for the period ahead.
Either way, your profit or loss for the period appears on the balance sheet, which shows your cumulative score to date. That score represents how much cash remains today if you paid off everything you owe with everything you own. What’s left, the balance, is your ownership, your equity, and your profit or loss so far.
Once you understand the relationship between the financial statements, you can make more informed decisions about what to do next to increase your chances of winning the money game.
Importance of Creating a Profit Loss Statement
As a small business owner, it’s important that you schedule time to prepare a profit and loss statement. You may feel your time may be better spent on managerial issues or improving your products or services. But while these key functions help grow your business, you want to consider spending some time to prepare and understand your income statement. It provides crucial information on the health of your business by letting you know your revenue and expenses, with the difference being the net profit or loss. Compare this to your budgeted figures to analyze your progress so you can take additional steps towards success. Using an accounting system, such as QuickBooks Online, you can generate a Profit and Loss statement automatically. Learn how today.