How to understand a profit and loss (P&L) statement: A beginner’s guide

Prophix Imageprophix May 15, 2024, 8:00:00 AM

The finance world is filled with business jargon that can quickly become confusing for those outside the Office of the CFO. There are different types of financial statements, accounting documents, and analyses involved with reporting on your financial performance.

But what specifically is a profit and loss (P&L) statement? In this article, we’ll take you through what it is and how you use it.

What is a profit and loss statement?

Simply put, a profit and loss (P&L) statement is a document that outlines a company's revenue and expenses over a certain period. The statement is usually broken up into different categories with individual entries of earnings and spending, with total profits and losses outlined at the bottom.

A P&L statement will usually include numbers from the previous year along with this year’s numbers so the finance team can compare them.

Other names for a profit and loss statement

Companies will often use different terms interchangeably with “profit and loss statement.” The terms used could differ depending on the company, industry, or jurisdiction. Some of the alternate terms include:

  • Income statement
  • Earnings statement
  • Operating statement
  • Revenue statement
  • Statement of profit and loss

How do profit and loss statements work?

A P&L statement reports on an organization’s financial performance, which can be compared to competitors in the same industry.

Each entry on the statement shows either a revenue stream or an expense, meaning the company can identify areas of improvement and be more prescriptive about cash burn moving forward.

Because a P&L statement breaks down revenue and expenses by account, managers, VPs, and even the CFO can quickly determine how each account affects the bottom line. While they’d need to dive deeper into each one to make cuts or increase budgets as needed, a P&L statement is usually where these decisions start.

What’s the difference between a profit and loss statement and a balance sheet?

Often confused for each other, a P&L statement outlines revenue and expenses, while a balance sheet contains liabilities, long-term assets, and shareholder equity over a certain period. They’re each used to answer different questions and are the basis for different reports.

What to include on a profit and loss statement

What exactly gets included in a P&L statement? The more granular line items can vary from company to company, but generally, P&L statements are broken up into a few main categories.

  • Sales (or revenue)
  • Cost of Goods Sold (COGS)
  • Advertising and marketing
  • Selling, General, and Administrative (SG&A) expenses
  • Taxes
  • Interest expense
  • Net income

Example of a profit and loss statement

This example of a simple P&L statement from Wise includes everything you’d see in a typical statement, from how much the company spends on advertising to how much revenue it’s bringing in through sale.

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Types of profit and loss statements

Not only do the line items within a P&L statement differ from company to company, but different methods can be used to produce the statement as well. Here are the two main methods.

Single-step method

A single-step P&L statement is a consolidation of a company’s revenue and expenses into just two equations for easy reporting. The total gains are usually outlined at the top of the statement, with the total losses at the bottom. This is a simplified version of a P&L statement.

The pros of using the single-step method
This is an easy way for businesses to report on P&L, with a simple equation for each category. This method produces a digestible statement for stakeholders.

The cons of using the single-step method
With the single-step method, it’s difficult for a business to identify areas of opportunity. There is no visibility into the expenses, revenue streams, and where a company may want to cut costs.

Multi-step method

The multi-step method for P&L statement creation, as you may have guessed, is the more detailed version of the single-step method. This method involves detailing every category for revenue and expenses and using a variety of equations to summarize the total profits and losses.

The pros of using the multi-step method
An itemized breakdown of costs and revenue allows a company to conduct a deeper analysis of its financial performance. This can lead to better decisions from the Office of the CFO in all things related to budgets, business strategy, and overall financial performance.

The cons of using the multi-step method
A multi-step P&L statement is much more time-intensive to produce from an accounting standpoint. Also, depending on the length, it can be difficult for investors and other stakeholders to sift through all line items easily. The amount and granularity of data needed for these statements also create a ton of manual work unless a financial performance platform is used.

How to create a profit and loss statement

Now that you understand what a P&L statement is, and what the types are, let’s take a look at how to make one.

A simple yet complete version of a profit and loss statement involves the following steps.

  1. Choose a reporting period: Oftentimes by law, companies are required to produce a P&L statement at the end of each fiscal year. However, some companies choose to report profits and losses quarterly or bi-annually.

  2. Gather data covering revenue and expenses: Collect your data from your accounting tool regarding company revenue streams, and a detailed list of expenses so you can prepare each line entry.

  3. Total revenue: Sum up your total revenue from each applicable channel.

  4. List your cost of goods sold: List your COGS data into individual entries to maximize the visibility of the cost breakdown.

  5. List your expenses: List your other overhead business expenses in additional line entries.

  6. Determine your EBITDA: Your Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) breakdown will give you another way to assess overall profitability and should be included in your statement.

  7. Determine your net income: Based on everything listed above, conduct the simple equation to determine your company’s net income.

Some software tools offer handy profit and loss statement templates and can also provide additional resources on operational planning to guide you through preparing more in-depth P&L statements.

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FAQs about profit and loss statements

After defining how to create a statement, you may still have a few P&L questions left over. Here are some of the most frequently asked questions about these essential documents.

Who is required to prepare a profit and loss statement?

For the most part, any publicly traded company is required to prepare a profit & loss statement each fiscal year. Both regulatory bodies and investors rely on these statements. The former to ensure organizations are compliant, and the latter to make better investment decisions.

Self-employed individuals may also be required to prepare a statement if they’ve applied for funding. Private companies operating in some industries may need to produce these statements as well. Finally, some jurisdictions may require that most, if not all, companies produce P&L statements.

It’s important to research the laws pertaining to your jurisdiction to be sure of whether your company must prepare one.

Who reads a profit and loss statement?

P&L statements are incredibly useful documents, and as such are read by a number of people:

  • Investors: Both public and private companies might make P&L statements available to investors to encourage their investment.
  • The Office of the CFO: The P&L statement is both produced and used by the Office of the CFO. Changes to budgets, business strategy, and more may all be determined by what shows up in this statement.
  • Analysts and consultants: P&L statements are particularly useful for people brought in to analyze an organization’s financial health to help reduce costs and improve profits.
  • VPs and the C-Suite: An organization’s leaders will typically look at a P&L statement before making serious decisions since it’s a useful snapshot of the organization’s financial health.

Why is a profit and loss statement important?

Aside from being required by law in most cases, a P&L statement is a powerful document a company can provide to investors and other stakeholders to report on its current financial performance.

How to use your profit and loss statement to drive business growth

Producing a P&L statement doesn’t have to be a stress-inducing task. By choosing a method, gathering data, and following the steps outlined earlier, your team will be well on its way to producing reliable P&L statements.

For automation and streamlined processes that go above and beyond P&L, consider Prophix One. Prophix One is a Financial Performance Platform that centralizes all the financial data you need for building P&L statements, reporting on financials, and more.

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