How to Prepare a Profit and Loss Statement
Do you know how much money you’re making?
It’s kind of an odd question to ask a business owner, but it’s also one with a surprisingly complicated answer. To figure out your profit, you can’t just add up your revenue, but you also have to account for expenses like rent, employee paychecks, damaged inventory, bank fees, business internet and phone plans, and a host of other possible revenue-draining activities.
Enter the profit and loss (P&L) statement, or income statement. It’s a relatively simple, line-by-line explanation of, well, your company’s profits and losses, all added up to a tidy summary of your net income.
Along with showing you whether your business is in the black, income statements also show banks and investors how you’re doing so they decide on things like loan amounts and interest rates. Most importantly, a P&L statement can help you make key decisions about where to cut costs and how to up profits.
You don’t have to prepare a P&L statement on your own. Plenty of accounting software will do it for you. But if you don’t want to invest in accounting software or you just want to draw up your own statement, no worries—that’s what we’re here for.
Steps for making a P&L statement
Step 1: Figure out a format
If you opt out of accounting software, a spreadsheet program like Excel or Google Sheets will help you keep the process simple. Depending on the product you use, you can find an easy template instead of building a document from the ground up. For instance, Microsoft Office offers a series of Excel templates for P&L statements.
The U.S. Small Business Association also offers a simple income statement template you can easily download, print, and fill out.
Step 2: Choose a time frame
Most businesses calculate their profits and losses on a monthly, quarterly, or annual basis. If a lender or investor asked you for a P&L statement, they should specify the time period they need to see.
Otherwise, just make sure to choose a time frame that shows you a general trend without overwhelming you with too much data; less than a month is probably too little time to reveal trends, while more than a year is probably too much.
Step 3: List revenue
For most small businesses, revenue equals sales, or goods sold—such as the amount of hair products sold by your salon, the number of baked goods sold by your cafe, or the number of printouts sold by your copy shop. But depending on the business, revenue could also include things like rent money, tax returns, or licensing agreements.
Each revenue source gets its own line on your profit and loss statement. Once you’ve listed each source, total them for your gross revenue. Make sure to break each source down by month—you’ll want the calculated totals of each revenue source for each month, not just the sum total of all revenue.
Step 4: Calculate direct costs
Now that you’ve totaled your revenue, it’s time to see just how profitable your business is by adding up your direct costs, or costs that relate directly to the production of the goods you sell.
If you sell a physical product, direct costs can also be called COGS, or cost of goods sold—in other words, how much it costs to make the goods you sell.
Not sure what expenses count as COGS? Let’s say you sell holiday-themed oven mitts on Etsy. To make your goods, you have to buy fabric, thread, a sewing machine, scissors, pins, patterns, and a host of other materials. The money you spend purchasing those items is your direct cost.
What if your business provides a service instead of goods? Since you don’t sell a physical product, you don’t have COGS, but you do still have direct costs. For instance, if you’re a psychologist, your office space is essential to the service you provide: without an office, you can’t offer services. So in this case, the money you pay for the office would be one of your primary direct costs.
Wait wait, there’s more! Direct costs can also include the costs of the labor that goes directly into your product or service. Let’s imagine you’re the owner of a small lawn mowing company. Purchasing a lawn mower isn’t your only direct cost—the amount of money you pay an employee to push the lawn mower is also a direct cost.
Consider using an accounting software
Step 5: Calculate gross profit
So now you know what your direct costs are. But do they outweigh what you charge customers for your products or services? Let’s find out: subtract your direct costs from your total revenue to get your gross profit. Hopefully, you’re left with a positive number that puts your business comfortably in the black.
You can also calculate your gross margin, which represents your gross profit as a percentage. Just subtract your direct costs from your gross revenue, and then divide that number by the gross revenue. Then simply multiply that number by 100. Hint: a higher gross margin indicates higher efficiency, which is excellent for any small business.
Step 6: Calculate operational and nonoperational expenses
Unfortunately, the buck doesn’t stop with your gross profit: other crucial expenses keep your business up and running, and you need to account for those too. After you run your gross profit, total your business’s operational and non-operational expenses:
- Operating expenses (OPEX) are any expenses necessary to your business that aren’t direct costs, or any money that doesn’t go directly into creating goods or supplying services. Depending on the type of business you run, these could include monthly utilities, business internet and phone plans, hardware and equipment, marketing costs, office supplies, building and equipment repairs and maintenance, and anything else that impacts your day-to-day business operations.
- Non-operating expenses are (hopefully) one-time expenses like legal fees, tax penalties, or interest on a business loan.
Here’s where things get a little confusing. There are multiple terms for operating expenses that mostly mean the same thing but that can be split into separate categories on your P&L statement. A few alternate terms you’ll want to get comfortable with include these:
- Administrative expenses are general expenses not specific to any department. For instance, if every department in your business sends out letters, not just the HR or payroll department, the cost of the stamps and envelopes would count as an administrative expense.
- Overheads can refer to the fixed costs of running a business that don’t vary from month to month (in contrast with operating costs, which can fluctuate). If you pay the same monthly fee for your accounting software, that would count as a fixed cost, or overhead. Complicating matters, though, overheads may also mean all indirect labor and production costs, while operating costs can mean the costs of actually running a business.
- SG&A stands for selling, general, and administrative expense. Basically, the term encompasses everything except for COGS, direct costs, research and development expenses, and interest on business loans.
Depending on where you look, operating expenses can also be called indirect expenses (as opposed to direct expenses).
Juggling all these terms is an obnoxious addition to an already complicated process—but just know that no matter what you call it, anything outside of your direct costs is an indirect expense that you subtract from the gross profit to get your net profit.
Step 7: Get your bottom line
It’s time for the moment of truth: is your business profitable or not? Steel yourself, take a deep breath, and subtract your total expenses from your gross profit to get your net profit.
Is your net profit positive? Nice! You’re on track for financial health. Is it low, zero, or in the negatives? It’s time to reevaluate some business practices. That could mean cutting down your OPEX (operating expenses), downsizing departments, or switching raw materials manufacturers to reduce your COGS (cost of goods sold).
Other inclusions: EBIT, EBT, and EBITDA
The steps above show you how to create a simple, straightforward income statement; you won’t need any more data than what we’ve listed here to fill out the U.S. Small Business Association’s template.
But maybe you’re doing in-depth business forecasting, or maybe your bank asked for more info before approving your loan. In that case, you want a longer, more detailed, and more accurate P&L statement, which means getting familiar with these abbreviations:
- Earnings before interest and taxes (EBIT): The total of your business’s net income without accounting for income taxes and loan interest.
- Earnings before tax (EBT): The total of your business’s net income plus the taxes you expect to pay (based on your business’s projected tax liabilities).
- Earnings before interest, taxes, depreciation, and amortization (EBITDA): The total of your business’s net income without accounting for income taxes, loan interest, or depreciation and amortization.
Depreciation refers to the constantly lowering value of your business’s physical assets, like a company car or office building. The more you drive the car, the more its value depreciates.
Amortization refers to the constantly lowering value of your business’s non-physical (or intangible) assets, like patents, copyrights, and trademarks.
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Frequently asked questions
Who is responsible for creating P&L statements?
The answer largely depends on the size of your business, but P&L responsibility could fall to your CPA, your CEO, or you, if you’re self employed.
Are there multiple types of income statements?
Yes. There’s the typical P&L statement detailed above, and there’s a pro forma P&L, which is an income statement you fill out when you first start a business. How do you figure out revenue for a business that only just started? Well, to put it frankly, you give it your best guess—that makes it a projected profit and loss sheet, not a record of current profit and loss.
If this is your first P&L (or pro forma P&L), make sure to lowball your revenue and highball your expenses. This is a great time to detail all of your expenses in full, from the electricity bill to the replacement staplers you just bought. Having a full list of expenses can help you moderate overheads and operating costs, which helps you build frugal business practices into your company right from the start.
Where do I get all the data I need for my P&L statements?
There’s a lot of financial data for you to include in your P&L statement. Like, a lot. Finding a starting point can be intimidating, but it’s much less so if you already have a great bookkeeping system in place. If you do, you should have easy access to your company’s receipts, invoices, pay stubs, credit card payments, tax data, accrued interest, and more so you can sit down and start running the numbers.
If you don’t have a great bookkeeping system in place yet, cut yourself some slack—and then get right on creating one now. (Literally now. Right now. Step away from this page and get thee to a bookkeeper.)
If you do cash transactions, start keeping receipts and storing them in a logical, orderly way. Organize your general ledger. Hire a part-time bookkeeper for a small fee or invest in bookkeeping software that keeps all your data in the same place.
Getting organized—including entering all your information into new accounting software—can be a steep learning curve. But apart from creating excellent products and services and hiring fantastic employees, there’s next to nothing more important to your business than accurate, detailed financial records, profit and loss statements included.
With the right financial documents on hand and sheer confidence in your Excel formula skills, creating a simple profit and loss statement is totally doable. Once you have the process down, feel free to pull data for a P&L statement whenever you need to—it’s the best, fastest, and cheapest way to quickly evaluate your small business’s financial health.
Want to learn more about how calculating profit and loss can help you grow your business? Check out our piece on how to effectively manage your company’s profit and loss.
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