What is a profit and loss (P&L) statement: Definition, examples, and uses

A profit and loss (P&L) statement is the same as an income statement. It’s a financial document that includes the revenues and expenses of a company. Business owners use the P&L to assess the company's profitability—how much money a company makes. 

Knowing how to read a profit and loss statement is key to making informed business decisions. It shows you where you might be able to cut costs. This article will cover what a P&L is, why it's important, and how business owners should analyze it.

Profit and loss (P&L) statement definition

A profit and loss statement is a snapshot of a company's sales and expenses over a period of time, such as one year. It shows company revenues, expenses, and net income over that period. The bottom line on a P&L will be net income, also known as profit or loss. The profit and loss formula is: 

Revenue - expenses = profit or loss

Types of profit and loss statements

The profit and loss statements show how well a business is performing and how profitable it is. There are two types of P&L statements—the single-step and the multistep method. Each method has pros and cons, and the choice depends on the nature and complexity of the business.

Single-step method

The single-step method is simple, straightforward, and involves only one calculation. This method subtracts all expenses from revenues to get net income.

An important distinction is that the single-step P&L doesn't separate revenues and expenses into different categories.

The disadvantage to the single-step method is that it doesn't provide as much detail. This makes it difficult for businesses to analyze their profitability. However, the single-step method is quick and easy to calculate. It works for businesses that don’t have many expenses.

Multistep method 

The multi-step method is a more complex way of preparing a profit and loss statement. It does involve more calculations and classifying expenses. But it makes assessing your company's profitability easier. 

The multi-step method will calculate gross profit, operating income, and net income. It groups the cost to make products or services as costs of goods sold (COGS). The remaining expenses are either operating or non-operating. 

Example of a profit and loss statement

Here’s what a simple profit and loss statement would look like using the multi-step method, which is what many businesses use. This profit and loss statement example categorizes revenues and expenses.

Components of a P&L statement

There are many ways to format a P&L statement, but all versions include the same basic information. Sales are at the top of the P&L statement, while expenses appear below. The profit or loss is the difference between the two.

Revenue

Revenue is the money your business makes from selling goods or services. It’s the very first line on the profit and loss statement. For example, if you sell 1,000 products for $200 each, your total revenue is $200,000.

Gross revenue vs. net revenue

Gross revenue is the total amount you made before accounting for any discounts, returns, or expenses. 

Gross revenue is also known as: 

• Total revenue
• Total sales 
• Gross sales 

Net revenue is the money you make after deducting discounts and returns. Net revenue is also known as net sales. 

Net revenue = gross revenue - discounts and returns

For example, if you sold $200,000 in merchandise—your total revenue—but you ran a sale and had some returns. The sale discounts were $10,000, and there were $5,000 in returns. 

Your net revenue is:

Net revenue = Gross revenue - discounts and returns 

Net revenue = $200,000 - $15,000 

Net revenue = $185,000

Cost of goods sold (COGS)

Cost of goods sold (COGS) are the cost of materials and labor a company uses to make a product or service. It’s also known as cost of sales. The costs can include raw materials or direct wages for employees. But also certain overhead costs, such as utilities. 

Gross profit

Gross profit is the money you make from sales after subtracting your cost of goods sold.

Gross profit = net revenue - cost of goods sold

For example, you make $185,000 in net revenue, but it takes you $125,000 to make all the products. 

Your gross profit is: 

• Net revenue: $185,000
• Cost of goods sold: ($125,000)
• Gross profit: $60,000

Expenses

Expenses of a business include all the costs to generate revenue. COGS are expenses that show up on the top part of the P&L before gross profit. Other expenses can be operating or non-operating.

Operating expenses

Operating expenses are the costs of running your business. While COGS are for making a product, operating expenses are the costs to support that process.

Operating expenses include:

• Rent
• Marketing costs
• Salaries for admin staff
• Depreciation
• Licensing fees

Non-operating expenses

Non-operating expenses are costs not part of your core operations. These include taxes, fines, legal fees, and interest. Non-operating expenses include anything that’s unlikely to happen again. For example, losses due to shutting down a business operation. 

Income

Income is how much money you make in your business. There are two key types of income—operating and net income. 

Operating income

Operating income is a business's income from its core operations. It excludes non-operating expenses, such as taxes or interest expenses. This type of income measures how well a company generates money from its main business.

Operating income = Gross profit - operating expenses

For example, your business has the following operating expenses: 

• Rent: $10,000
• Salaries: $5,000
• Marketing $2,500
• Total: $17,500

Your gross profit was $60,000, and thus your operating income is: 

• Gross profit: $60,000
• Operating expenses: ($17,500)
• Operating income: $42,500

Net income

Net income is your bottom line—the last item on your P&L. It's the money left after subtracting all expenses.

Net income = revenue - COGS - operating expenses - non-operating expenses

Net income comes after both operating and non-operating expenses on the P&L. It’s a measure of the money left over for shareholders or owners.

For example, you have $42,500 in operating income, $2,500 in tax expenses, and $5,000 in interest expenses. 

Your net income is: 

• Operating income: $42,500
• Taxes: ($2,500)
• Interest expenses: ($5,000)
• Net income: $35,000

How do you create a profit and loss statement?

The P&L will include three key components—revenue, expenses, and income. There are three key steps to making a profit and loss statement. 

1. Start with revenue

Determine what period you want to create a profit and loss statement for. This can be any period, but it’s generally best practice to put together a P&L monthly to help identify trends. 

You’ll want to calculate your gross revenue ‌for that period and list it on the top line of your P&L.

2. Calculate your costs

After accounting for all your revenues, group your expenses into one of three categories: 

1. Cost of goods sold (COGS)
2. Operating expenses
3. Non-operating expenses

COGS are all the costs of making a product. For a service business, which do not make a physical product, COGS can include labor for employees performing the service. For example, a hair stylist’s COGS would include the time spent styling hair.

You'll group all the other costs of running your business as operating expenses. Non-operating expenses should be everything that's left. This will be the money you spend on things like taxes and interest.

A hairstylist would have operating expenses like cosmetic supplies, insurance, and marketing. Non-operating expenses may include interest on business debt or writing off unsellable inventory. 

3. Figure out your net income

This is the last step. It's subtracting all the expenses from your revenue. The net income will either be a profit or a loss—or in very rare cases, zero.

Analyzing a P&L statement

Once you’ve put together your profit and loss statement, it’s useful to analyze it. It’ll show whether you’re profitable or not. But it also allows you to identify where you can save or reduce spending.

How do you determine profitability?

Profitability measures how much a business earns compared to its expenses. There are different ways to measure profitability. Two common measures of profitability are gross profit margin and net profit margin.

The gross profit margin is gross profit divided by revenue. It shows how profitable a business is at making products or services.

Gross profit margin = gross profit / revenue 

The net profit margin is net income divided by revenue. It’ll show what percentage of revenue you’ll keep after all expenses.

Net profit margin = net income / revenue 

Say a window maker’s revenue was $500,000 last year. They spent $300,000 in COGS to make the windows. Net income for the year was $40,000.

The company's gross profit margin is 40% or ($500,000 - $300,000) / $500,000.

Its net profit margin is 8% or $40,000 / $500,000.

Many small businesses aim for a net profit margin of 10%, although this will depend on your industry.

Assessing financial ratios

Beyond profitability, there are other ratios that the P&L can help you calculate. But you’ll need the help of the balance sheet.

Other key ratios you’ll want to look at are efficiency ratios. These assess how well a company uses its resources. They use one item from the P&L and one from the balance sheet.

The accounts receivable turnover ratio shows how well a business is managing accounts receivable. Accounts receivable is the amount of money that your customers owe you. You’ve already sent them the products, but haven’t collected payment yet. It’s sales divided by the average accounts receivable. The accounts receivable turnover ratio shows how well you’re collecting that money. 

Accounts receivable turnover = sales / average accounts receivable

A low or declining accounts receivable turnover shows a declining ability to collect customer payments.

The inventory turnover ratio tells how well a company is managing inventory. The formula for the inventory turnover ratio is the COGS divided by the average inventory.

Inventory turnover ratio = cost of goods sold / average inventory

You can also use an inventory turnover calculator to help you see how your business is doing. 

Comparing P&L statements 

P&L statements are most useful when comparing them to previous periods because they allow you to track progress over time. They’re also useful when it comes to setting goals for your business. 

You can also compare your P&L to companies in your industry. This will help you determine where you stand relative to other businesses

Why a profit and loss statement is important

The profit and loss statement is important because it tells you if your business is turning a profit. It’ll also show where you’re spending your money.

A profit and loss statement is important for business owners to:

• Assess and evaluate profitability
• Track performance and costs over time
• Find strengths and weaknesses, such as problem areas
• Price goods or services by assessing the cost of goods sold
• Make informed decisions about budgets and strategies
• Set goals for revenue generation ideas or cost cutting

Using a profit and loss statement to grow your business

As a small business owner, you need to be aware of your company’s financial health. One of the best ways to do this is by analyzing your profit and loss statement. Regularly reviewing your P&L will give you a better idea of how your business is doing. 

Quickbooks’ accounting software makes creating your P&L and other financial statements easy.