Can you say that your business is profitable?
Picture this: Your expenses surpasses income, and you find yourself in a pile of bills to pay. Not the news any business owner wants to hear!
That’s precisely why calculating your profits and losses is crucial and profit and loss statement does exactly that. Let’s understand why it’s vital for your success in this ever-changing market.
In this blog, you will understand the core concept of the P&L Statement, its importance for businesses, its key components, and how to create one.
What is a Profit and Loss Statement?
A Profit and Loss Statement, or Income Statement, is a financial report that shows your business’s revenues, costs, and expenses during a specific period.
Typically, the P&L Statement covers a fiscal quarter or year, but it can be generated for any specific period as needed.
Revenues – Expenses = Net Profit or Loss
Importance of a Profit and Loss Statement
For any business no matter how big or small, understanding the significance of a P&L Statement cannot be overstated.
Here are some key reasons why it holds such importance in business accounting:
a) Financial Performance Evaluation: The P&L Statement allows you and other stakeholders to assess the business’s financial performance over a given period of time. You can thus determine what tasks increase ROI for the business or where losses occur.
b) Decision-making Tool: Business decisions should be backed by data, and the P&L Statement provides vital financial data that influence decisions related to cost-cutting, expansion, investment, and pricing strategies.
c) Attracting Investors and Lenders: Potential investors and lenders often evaluate the P&L statement to assess your business’s eligibility . A positive P&L Statement can give confidence and attract external funding such as bank loans
d) Identifying Trends and Patterns: By comparing P&L Statements from different periods, you can identify trends and patterns in your business’s performance. This analysis enables you to detect potential problems and capitalise on growth opportunities.
e)Meeting Legal Requirements: Businesses must submit financial statements, including a profit and loss statement to regulatory authorities in many countries. In case of failure to comply, you might have to pay penalties.
Key Components of a P&L Statement
Depending on the type of business and its complexity, such as whether you sell items rather than services, have multiple sources of income, or have many expenses, a P&L statement will differ from business to business.
Listed below are most common components of the P&L statement.
a) Revenue: This section lists all the revenue streams generated by the business during the specified period. It includes sales revenue, service revenue, interest income, and any other income sources.
b) Cost of Goods Sold (COGS): COGS represents the direct costs incurred in producing goods or providing services. For example, cost of goods for a manufacturing business may include, raw materials, labor, and other expenses.
For service-oriented businesses, it includes costs related to service delivery.
c) Gross Profit: The gross profit is calculated by subtracting the COGS from the total revenue. It indicates how efficiently your business produces goods or delivers services.
d) Operating Expenses: Operating expenses include all indirect costs incurred in running the business, such as salaries, rent, utilities, marketing , and other administrative costs.
e) Operating Income: Your earnings before taxes, depreciation, interest, and authorization is called operating income. To determine operating income, subtract operating expenses from gross profit.
f) Net Profit or Loss: Finally, the P&L Statement reflects the net profit of the business, which is the total amount after deducting all expenses. Subtract your total expenses from your gross profit to calculate your net profit.
How to Create Your P&L Statement: A Step-by-Step Guide with a example
The Profit and Loss Statement is a crucial tool for your business to assess their financial performance accurately.
Here’s a step-by-step guide to create a basic P&L statement using a hypothetical example:
Step 1: Calculate Your Business Income
Business income refers to the money received as payment for goods and services. Let’s assume that your business sells cycles.
Example:
- Number of cycles sold: 100
- Average unit price: Rs. 2,500
Calculation:
Business Income = Number of cycles sold x average unit price
Business Income = 100 x Rs. 2,500 Business income
= Rs. 2,50,000
Step 2: Calculate Cost of Goods
Cost of goods sold (COGS), includes expenses related to producing goods or services.
Example:
- Cost per cycle from the supplier: Rs. 1,000
Calculation:
Sales cost = number of cycles sold x cost per cycle from the supplier
Sales Cost = 100 x Rs. 1,000 Sales Cost = Rs. 1,00,000
Step 3: Determine Your Gross Profit
Gross Profit is the difference between revenue and COGS.
Calculation:
Gross Profit = Business Income – Sales Cost
Gross Profit = Rs. 2,50,000 – Rs. 1,00,000
Gross Profit = Rs. 1,50,000
Step 4: Calculate Your Operating Expenses
Operating expenses cover day-to-day business activities and are essential to determine the company’s efficiency.
Example:
- Rent: Rs. 15,000
- Electricity and Water: Rs. 5,000
- Staff Payroll: Rs. 40,000
- Marketing Expenses: Rs. 10,000
- Office Supplies: Rs. 2,000
Calculation:
Total operating expenses = rent + electricity and water + staff payroll + marketing expenses + office supplies
Total operating expenses = Rs. 15,000 + Rs. 5,000 + Rs. 40,000 + Rs. 10,000 + Rs. 2,000
Total operating expenses = Rs. 72,000
Step 5: Evaluate Your Operating Profit
Operating Profit is the difference between Gross Profit and Operating Expenses.
Calculation:
Operating Profit = Gross Profit – Total Operating Expenses
Operating Profit = Rs. 1,50,000 – Rs. 72,000
Operating Profit = Rs. 78,000
Step 6: Adjust Other Income and Expenses
To calculate EBITDA, add depreciation and amortization to the operating profit.
Example:
- Depreciation: Rs. 5,000
- Amortization: Rs. 3,000
Calculation:
EBITDA = Operating Profit + Depreciation + Amortization
EBITDA = Rs. 78,000 + Rs. 5,000 + Rs. 3,000 EBITDA
= Rs. 86,000
Step 7: Net Profit or Loss
Net Profit is the final result after subtracting interest, taxes, and depreciation from EBITDA.
Example:
- Interest: Rs. 8,000
- Taxes: Rs. 12,000
Calculation:
Net Profit = EBITDA – (Interest + Taxes + Depreciation)
Net Profit = Rs. 86,000 – (Rs. 8,000 + Rs. 12,000 + Rs. 5,000)
Net Profit = Rs. 61,000
Net Profit Percentage
To calculate the net profit percentage, divide the net profit by the business income and multiply by 100.
Calculation:
Net Profit Percentage (%) = (Net Profit / Business Income) x 100
Net Profit Percentage (%) = (Rs. 61,000 / Rs. 2,50,000) x 100
Net Profit Percentage (%) = 24.4%
Key Takeaways
- Performance Evaluation and Benchmarking: A well-prepared P&L Statement provides a benchmark to measure your business’s performance over different periods.
- Identifying Costs and Efficiency Improvements: P&L Statements reveal costs that impact your business’s financial health
- Paving the Way for Strategic Decision-making: Armed with insights from your P&L Statement, you can make informed decisions about business resources.
- Opportunity for loans: Public and private banks and other lenders seek clarity on your business’s financial health.
- Forecasting and Planning for the Future: By studying your past P&L Statements, you can develop reliable forecasts and future projections.
So there you go, start planning for your future by making your present business more profitable.