Profit and Loss Statement : Meaning, Example, Importance & Types

What is Profit & Loss Statement?

A profit and loss (P&L) statement is a financial statement that summarises the revenues, expenditures, and expenses incurred for a certain time, which is commonly a quarter or fiscal year. These records reveal a company’s potential or inability to earn profit through increased revenue, cost reductions, or both. P&L statements are frequently given in cash or accrual format. Corporate managers and investors use P&L statements to evaluate a company’s financial health.

Geeky Takeaways

• The profit-and-loss statement is an important financial measure that reveals the company’s profitability and financial health.
• It helps management identify strengths and weaknesses, enabling strategic decision-making for future corporate operations.
• Stakeholders and investors use P/L figures to evaluate the company’s profitability and investment risks.
• Companies use historical profit and loss statements to set goals and benchmarks for future financial planning.
• P/L statements help identify areas for improvement and facilitate trend analysis by assessing financial performance over time.

How do Profit and Loss (P&L) Statement Work?

P&L statement also referred to as income statement, presents a summary of the revenues, costs, and expenses made by an organisation during a particular period. This is how P&L statements work:

1. Revenue Recognition: The identification of income is the first entry in P&L statements. This comprises revenue from any other sources in addition to those that result from the business’s main business activities (e.g., sales of goods or services).

2. Cost of Goods Sold (COGS): To determine the gross profit, the direct expenses related to the production of goods or services are deducted from the overall revenue. Expenses that are directly linked with the manufacture of a product, such as labour and basic materials, are included in COGS.

3. Gross Profit: Gross profit, which is the profit generated from the fundamental business operations of a company, is the third component. Determined by deducting cost of goods sold (COGS) from total revenue, it provides a fundamental evaluation of profitability before taking into account the operating expenses.

4. Operating Expenses: Operating expenses include a variety of expenses that are essential in the operation of the business. These include research and development costs, selling and business and administration expenses, and additional overheads. By deducting these expenses from the total profit, the operating profit is calculated.

5. Non-Operating Income and Expenses: This category includes non-operational items, which includes interest income, asset sale gains or losses, and other activities that are not considered main business activities. These items have an effect on the company’s final profit.

6. Profit Before Tax: The profit before taxes (PBT) is calculated by deducting non-operating expenses and total operating expenses from the operating profit. It signifies the profit generated prior to the deduction of income tax.

7. Income Tax Expense: This category includes both present and deferred income tax expenditures. A percentage of the company’s profits must be set aside to satisfy its tax obligations.

8. Net Loss or Profit (Net Profit): The net profit is the amount remaining after income tax expenses have been subtracted from the Profit before Tax. It signifies the total financial gain of the business over the chosen period. A negative result signifies a possible nett loss.

9. Analysis and Interpretation: The P&L statement is reviewed by various stakeholders, such as investors, management, and analysts, in order to examine the financial well-being of the organisation, trends in profitability, and the productivity of cost management strategies.

How to Prepare a Profit & Loss Statement?

A financial report known as a Profit and Loss (P&L) Statement, alternatively referred to as an Income Statement, provides a concise overview of the revenues, costs, and expenses accrued over a designated period—typically a fiscal quarter or year. It offers valuable insights into the profitability potential of a company through cost reduction, revenue growth, or both. The subsequent instructions detail the process of generating a profit and loss statement:

1. Define the Reporting Period: Determine the duration in months, quarters, or years for which the P&L statement will be generated.

2. Collect Revenue Data: Commence by assembling the revenues generated throughout the review period. Revenues, service charges, interest income, and any additional sources of revenue should be included. Ensure that any sales returns or discounts are deducted.

3. Calculate COGS: Direct costs associated with the production of products or services are included in COGS. This may include labour, basic materials, and manufacturing expenses. Gross profit is determined by deducting the cost of goods sold from total revenue.

4. Enumerate Operating Expenses: Determine and describe every operating expense. These may consist of rent, utilities, salaries, marketing costs, insurance, and any other expenditures that are directly associated with the operation of the company.

5. Extract Operating Expenses: To ascertain the operations profit (or operating income/loss), subtract the aggregate operating expenses from the gross profit.

Operating Profit = Gross Profit – Operating Expenses

6. Take into Account Other Income and Expenses: Add any non-operating revenue or expenditures, such as interest earnings, interest expenditures, and taxes. Pre-tax profit is calculated by adding non-operating income and subtracting non-operating expenses.

7. Tax Calculation: Determine the net profit by subtracting taxes from the before taxes profit.

8. Statement Format: Deliver the data in a logical and systematic fashion. Revenue, Cost of Goods Sold, Operating Expenses, Operational Profit, Other Income/Expenses, Before taxes Profit, and Net Profit are some examples of appropriate categories.

9. Evaluate and Assess: Verify your calculations and the accuracy of the statement. Determine information regarding the financial health of the company by analysing the results.

10. Interpret and Compare: By comparing the current P&L statement to those of prior periods, one can discern patterns and evaluate the financial well-being of the organisation. Incorporate the findings within the framework of your organization’s objectives and industry standards.

It is important to note that the format and particular entries on a P&L statement can differ due to industry regulations and accounting standards.

Example of Profit and Loss Statement (P&L)

Comparing P&L Statements

It is essential to compare income statements from several accounting periods in order to maximize correctness. The reason for this is that any changes that occur over time in terms of revenues, operational costs, spending on research and development (R&D), and net earnings are of greater importance than the figures themselves. A company’s expenses may grow at a considerably quicker rate than its sales, for instance, even while the company’s revenues may continue to grow at a consistent rate. Investors can further examine the financial health of a firm by comparing the profit and loss statement of one company with that of another company operating in the same industry and having a size that is comparable to the first company. It is possible, for instance, that doing so will disclose that one firm is more effective at minimizing expenditures and has a greater potential for growth than the other.

Methods of Creating Profit and Loss (P&L) Statement

Accrual Method

Cash Method

Using the accrual method, revenue is recorded as it is earned. Consequently, an organization that uses the accrual method records revenues that it expects to earn at a later time. For example, in the case of a business that provides a service or product to a customer, the revenue will appear on the P&L statement regardless the fact that payment has not been received. Likewise, liabilities are recognized and recorded in the financial statements of the organization, regardless of the fact that no expenses have been paid.

When cash enters and exits the business, only then does the cash method, also known as the cash accounting method, come into play. This straightforward approach accounts only for cash paid or received. When cash is received, a business documents the transaction as revenue; when cash is used to pay bills or commitments, the transaction is recorded as liability. This approach is often used by individuals and smaller organizations seeking to handle their personal finances.

Types of Profit and Loss (P&L) Statements

1. Single Step Income Statement : This basic version of a profit and loss statement is frequently used by smaller companies that have a reduced number of line items to report. This form of Income Statement only includes revenue and expense subtotals.

2. Multi-Step Income Statement : The single-step income statement has been succeeded by this form of income statement. Typically, subtotals are provided for gross profit and operating income, which makes for easier understanding and analysis.

3. Comparative Income Statement : This type of Income Statement presents the performance for various periods in columns that are put next to each other. This style is highly recommended for financial analysts and is commonly used in both quarterly and annual reports. It is easier to analyse the changing trends in expenses and profits by placing different years together. Quarterly reports can also include a modified version of this type, which presents the performance of the current quarter alongside with the performance for the entire year to date (YTD). MIS reports generated by popular accounting software such as Quickbooks, Xero, and Netsuite follow a similar structure, wherein they present P&L reports in columnar form, arranged by month.

4. Contribution Margin P&L Statement : The purpose of the Contribution Margin P&L Statement is to highlight the profit contributions made by different business units, products, or geographies. The method is used for the purpose of internal reporting. e.g. If the company has 5 different products, this balance sheet can be used for reporting the profits/losses from all differnet products.

Why are Profit and Loss (P&L) Statement Important?

Profit and Loss (P&L) accounts are essential financial documents that present a brief summary of the financial performance of a business during a particular time frame.

1. Financial Health Evaluation: The use of profit and loss (P&L) statements permits companies to assess their financial health through the complete declaration of revenues, costs, and expenses. This evaluation allows stakeholders to get knowledge about the financial health of the organisation.

2. Decision-Making Tool:  Profit and loss statements are used by management in order to arrive at informed choices relating to the the company’s activities, pricing strategies, cost management efforts, and future investments. It acts as an essential point of reference in the field of strategic planning.

3. Investor and Stakeholder Trust : P&L statements are used by investors and stakeholders, such as prospective investors, creditors, and shareholders, to evaluate the financial condition of a company. A P&L statement that is strong and constantly profitable has the potential to build confidence and encourage investment.

4. Budgeting and Planning : The use of P&L statements is essential in the process of budgeting and preparing for prospective financial ventures. By studying past performance, companies can establish achievable financial goals and efficiently distribute resources.

5. The Identification of Trends and Patterns: It is possible to identify trends and patterns in expenses, expenditures, and revenue when examining P&L statements for various time periods. This analysis enables management’s understanding of market behaviour, enabling them to easily modify their business strategies.

Conclusion

A P&L statement is a summary of a company’s income, costs, and expenses for a certain time frame. A balance sheet and a cash flow statement are the other two financial statements that public companies put out three times a year, or every three months. People who invest in and study businesses use financial records to figure out how healthy their financial standings are and how much room they have to grow.