Key to a healthy business is regular and holistic financial assessment. Understanding cash flow, calculating pre-tax, and doing tax returns are all a part of determining the financial health of your business. In addition to these, you should also put together a profit and loss statement.
In this blog post, we’re going to go over the profit and loss statements. We’ll discuss what they are and why they’re important, before laying out the types and advising you on how to put one together yourself.
Also called a P&L for short, a profit and loss statement is a financial document summarizing the following:
P&Ls are conducted quarterly or annually, and illustrate a company’s capability to generate profits when all spending is considered. Ideally, with a profit and loss statement, you can improve on particular areas to generate or increase profit over time.
If you run your own business or are self employed, it’s highly recommended you generate at least an annual profit and loss statement. Quarterly or monthly profit and loss statements will give you the clearest financial picture of your business and provide frequent places for improvement of cash flow and earnings.
Statement types depend on things like the size and profitability of your company, its needs and use cases, focus, and customer base.
Key to creating profit and loss statements ideal for your business is understanding each one in detail.
One of the simplest types of Profit & Loss single-step income statements use a singular equation to calculate profits.
The equation looks like this:
Net Income = (Revenues + Gains) – (Expenses + Losses)
This offers a straightforward picture of your financial activity and is one of the easiest profit and loss statements to put together.
More complicated than the single-step, the multi-step income statement uses multiple equations, forming a more complex picture of your finances.
The intention is to separate expenses and revenues by breaking down operating expenses (costs incurred to run the business), and non-operating expenses (not directly required for those activities).
To calculate your multi-step income statement, you need to first calculate the gross profit:
Gross Profit = Net Sales – Cost of Goods Sold
Once you have that, you can then calculate operating income:
Operating Income = Gross Profit – Operating Expenses
And finally the net income is established by adding together the operating income and non-operating expenses:
Net Income = Operating Income + Non-operating Items
With a comparative income statement, you can separate the results of multiple income periods into separate columns. This allows you to present a historical reading of your income and profits over a period of time.
Most commonly, these are presented with a time period for each column, with the most recent period on the left side of the table and going backwards in time further to the right.
You can use these income statements to better understand the spikes and dips in your earning periods over the course of a year, or longer if you wish.
Common size analyses are useful for business owners with more than one company, or a company large enough to require statements of separate sectors within the company.
The idea behind this type of statement is to reduce separate income readings to one figure, which can then be used to compare with other departments or companies. For instance, you might use a single percentage of sales figure in one department of your business, to compare against other departments.
Variance reports are effective at analyzing revenues, expenses, and profitability across the business. They typically include monthly variances to both current budgets, and the previous year’s actual earnings.
This kind of analysis allows you to observe the fluctuations in your earnings, contrasted with projected budgets across periods of time. They are a useful profit and loss statement type for determining the performance of your business.
In contrast to traditional, companywide profit and loss statements, a segmented statement further breaks down financial performance by providing data on specific areas within the business.
With a segmented profit and loss statement, you can determine the performance of your product line, location costs, department performance, or the performance of an individual team member.
This kind of income statement is most useful when you suspect certain areas are underperforming, which is ultimately dragging the whole business down when it is otherwise performing well. You can then focus on the underperforming area and address its lag directly.
Driver-based profit and loss statements are designed to forecast revenues and expenses for the remaining months of the year. So, if you’ve had a particularly interesting six months and you want some sort of picture of your business’s performance at the end of the year, you can perform a driver-based income statement.
These are useful when intending to implement new strategies before the end of the year and aiming to determine the projected results of those strategies, on the overall financial health of your business. This way, you can tactically prepare for risks and liquidity issues.
Composite profit and loss statements are highly detailed, accounting for multiple items across different time periods. They use both financial and non-financial metrics, and are most common in determining costs and revenues of particular cost categories.
For instance, your composite profit and loss statement might include a section on ‘digital advertising’ costs and ‘traditional advertising’ costs and revenues. This way, you can determine which type of marketing methods perform better at which times of the year.
Creating a traditional profit and loss statement means calculating figures on certain items related to your business. You’ll also need to state whether or not these figures are affected by VAT.
Forecast your sales by looking at things like:
Your sales write up should include gross profit, total sales, and cost of goods.
Expenses are what it costs your business to generate revenue. They can be anticipated by reviewing your cash outgoing from previous years, and forecasting any new expenses or raises in price upcoming.
Common expenses include:
Add all your expenses together and calculate the total. Be sure to specify the tax costs attached to each expense. You can include a pre-tax calculation as well.
Where gross income is income regardless of expenses, your net profit is the gross income with the expenses subtracted. This gives a clear picture of profit outside of all the necessary costs of running a business.
Certain trends will pop up in your profit and loss statement that communicate an issue that needs to be addressed in your business. These can be interpreted as warning signs which, if you keep up with quarterly or monthly P&L statements, you can catch before they cause any real problems.
As your business grows, it becomes more difficult to keep watch over each individual job or cost. Putting together your statement will allow you to gauge any declines or increases in profits and begin to assess causes and solutions early on.
When assessing profits, keep an eye on the progression of your gross profits, while taking into account seasonal trends and new products/services offered. If you notice an overall declining trend in your gross profits, perhaps conduct a segmented profit and loss statement to determine where exactly the losses are occurring.
Marketing is a crucial expense for any business. Ideally, you should spend around 10% of your sales revenue on marketing, in order to keep your business relevant.
Locating this in your P&L statement could mean you’re neglecting your marketing spending because something else has taken precedent. And while you may not see a downward trend in profits yet, this will likely follow as your business slips out of relevance due to decreased visibility.
Try to maintain the 10% rule in order to prevent this from happening, and pick periods in the year during which to increase marketing efforts or try something new.
When you start your business, you’ll probably pay yourself a small salary to help things get off the ground. Once profits start to climb however, be sure to update your salary as your business earns more.
The reason for this is, you don’t want to heap financial stress into your personal life by limiting your salary. It’s more stressful to take out money from your business savings, than it is to simply put aside a liveable salary each month. If you allow stress to build it will affect your business, possibly leading to burnout or poor business decisions that have dire consequences for your company’s financial health.
Profit and loss statements are financial documents presenting a reading of your company’s financial health and performance.
Anyone who runs a business or is self-employed should conduct quarterly or monthly P&L statements.
The many different types of profit and loss statements will assist you in specific ways of addressing your company’s cash flow and finances.
Writing your own statement requires putting together calculations of sales, expenses, and net profits.
Watch for declining gross profits in your business, as well as underspending on marketing efforts and failing to pay yourself a liveable salary.
