“Profit and Loss statement” – As a business owner, you may have heard about this several times. But do you know how to read and analyze a profit and loss statement?

Simply put, a profit and loss statement is a financial statement of your company’s financial health, providing an overview of revenues, costs, and expenses that your company has incurred in a given annual period. 

It is one of the 3 financial statements that most public companies issue every 3 months (quarterly) or every year (annually). The other two are – balance sheet and cash flow statement. These 3 financial statements give you a detailed insight into your company’s financial performance, allowing you to make better decisions and plan for the upcoming period or year.

What is a Profit & Loss (P&L) Statement?

A profit and loss statement is a financial statement that summarizes the following three important things during a specific period –

• Revenues 
• Costs of goods/services sold
• Expenses 

These reports show whether or not a business has successfully maximized profits via increased sales, decreased expenses, or both. Managers and investors may learn much about a company’s financial health by combing through its profit and loss accounts.

The P&L statement is also known as 

• Income statement 
• Statement of Operations 
• Statement of Income 
• Expense statement 

What Are the Two Ways of Preparing a Profit and Loss Statement?

A P&L statement can be prepared in two ways, by following the cash method or the accrual method. 

Cash Method 

Also known as the cash accounting method, this particular method is only used when cash goes in or out of your company. This means that it only accounts for received or paid cash.

When money comes into a company, it is considered revenue. When money leaves the company, it is considered an expense or asset since both scenarios involve cash. Many individuals and small businesses use this technique to track their money.

Accrual Method 

Using accrual accounting, money is accounted for as soon as it is earned. By doing so, a business that uses accrual accounting recognizes revenue in anticipation of its actual receipt. 

For instance, if a firm has delivered a product or service to a client but has yet to receive payment, it will report the revenue on its P&L statement. 

Similar to how assets are recorded even if payment has not yet been made, liabilities are recorded whether or not the corresponding costs have been paid for.

How To Read & Analyze Your Company’s P&L Statement?

To accurately read and analyze your company’s profit and loss statement, you must understand each head in the P&L statement. Here’s a quick overview of the profit and loss statement format. 

Revenue 

One of the best ways to tell whether your firm has been successful is to look at its income. This may be measured using either a cash basis or an accrual basis. Your total revenue for the period you choose will be shown on the top line of your profit and loss statement, or P&L.

Cost of Goods Sold (COGS)

The cost of goods sold is the price your business pays to provide the products or services. Materials, labor, and transportation are direct costs, whereas rent and general utilities are not considered here since they are indirect overheads.

Gross Profit

The gross profit is calculated by subtracting the cost of goods sold from the total revenue. Since this doesn’t include overhead expenses like rent, maintenance, and general utilities, it isn’t an accurate reflection of your net earnings.

Expenditures

Expenses are divided into 2 categories – direct and indirect.

Direct expenses are directly related to producing your product or service and are generally a part of the cost of goods sold. In contrast, indirect expenses cannot be traced directly to your product or service. These include rent, gas for the van, electricity bills, maintenance, etc. 

Operating Earnings

Also known as EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), operating earnings reflect your company’s profitability without considering external costs. 

These include external costs like interests, tax, depreciation, and amortization (settling a debt over time by making regular payments equal to the debt’s principal plus the interest accrued). 

Many financial experts agree that EBITDA is the most useful metric for evaluating a company’s health since it focuses on expenses that can be influenced by management rather than those beyond their control.

Interest Expense 

Interest costs are incurred when a firm borrows money via a loan, a line of credit, or even a credit card. Interest expenditure is the total amount spent repaying debt on a profit and loss statement over a given period.

Depreciation & Amortization

Depreciation and amortization is the allotment of Capital expenditures over each accounting period, usually a year,  incurred by a business towards its tangible or intangible assets, e.g., fixed assets, software, goodwill, intellectual property, heavy advertising expenditures, etc.

Earnings Before Income Tax 

This simply reflects how profitable your business is before it pays its income taxes. 

Income Tax Expense 

This shows how much tax you have paid or provided for on your income for a given period.

Net Profit 

The difference between your total revenue and your expenses, including direct and indirect expenses, is your net profit. It demonstrates your firm’s overall profit. 

Loss

Loss means when all corporate costs (direct or indirect) exceed your total revenue. 

Wrapping Up

• Where is most money spent at your company?
• In general, how big are your deals? 
• Is it possible to trim costs in any particular areas? 
• When do you have the fewest deals, on average?

Your profit and loss statement will provide the answers to all these inquiries, as you can generate a profit and loss statement for every month of your accounting year. The importance of understanding this is imperative to your company’s growth.

Maintaining an accurate profit and loss statement allows you to monitor your company’s financial health monthly, quarterly, or annually. By taking a hard look at the statement, you may get a good idea of how your company is doing. 

We are optimistic that after reading this blog, you have a fair understanding of what the P&L means, the general profit and loss statement format, the different components of a profit and loss statement, and what each means. 

However, if you still need help, you must get in touch with experts like GJM & Co. We will not only help you analyze your P&L statement but also prepare it for you, along with other financial statements crucial to your company’s performance. You can read more about our accounting and bookkeeping services

Should you have any queries or need consultation, Schedule a Call today or write to us at info@gjmco.in.