What is a Profit & Loss Statement?

So what exactly is a Profit and Loss Statement? For starters, you may hear this called several different things such as a P&L, an income statement, or even a statement of operations. A Profit and Loss Statement is a summary of revenue (income) and your expenses over a certain period of time. So, you may run a P&L Statement for the month or the quarter, or for the full year when you’re filing income taxes. It is just a summary of all those revenues and expenses broken down into different categories.

---

The Formula for a P&L Statement:
Revenue – Expenses = Profit or Loss

The top portion of your P&L Statement shows all of your streams of revenue or sources of income, and then you will have the expenses for your business below that.

So what exactly is revenue?

Well, revenue is any type of income that comes into your business. It does not include loans or grants. 

For example, if you’re a restaurant, revenue would include income from your food sales. If you’re a boutique, revenue may come from sales of clothing or accessories. If you are a service-based business, like a consultant or a social media manager, revenue will include income from services you sell.

One thing that I recommend as a proactive bookkeeper and tax strategist is to break down your streams of income into different categories. I’ll break this down in about the same three examples: restaurants, boutiques, and service-based businesses.

If you are a restaurant, you may want to break those streams of revenue into particular sales, like a deal you have a combo for, or break it between entrées, drinks, desserts, and that way you can see where your revenue is coming from.

If you’re a boutique, same thing. Maybe you want to break it down into clothing, shoes, accessories, handbags – whatever category you want to look at to see where your revenue is coming from.

For service-based businesses, we all have different packages or different services that we sell, and it’s important that we don’t just lump them all into revenue or income. We need to break it up so that we can see where the most income has been generated and make decisions based on that data.

So, if you’re setting up Quickbooks online, creating your own spreadsheets, or getting ready to have an accountant help you, make sure that your information is getting separated accordingly so that your Profit and Loss Statement is categorized and custom to your business. 

Let’s move on to expenses.

Expenses are things that your business uses, and they are not all necessarily tax deductible. Just because it is an expense on your profit and loss statement does not mean that it's 100% tax deductible, which is a misconception aboout profit and loss statements. 

Expenses are going to be things such as your cost of goods, advertising, legal and professional fees, supplies, office supplies, utilities, rent, etc. Just like with sources of revenue in your business, I also recommmend you break down your expenses into more categories. So for example, maybe with advertising you hire a social media manager, and you may also run Facebook ads. I break that down for my clients so they can see their return on investment on certain types of expenses. I do want you to break it down where it makes sense, where you're able to take the data from the profit and loss statement and make decisions based on that data. 

It is very important to know if you are a cash basis business or an accrual method business because they are two totally different types of accounting. Most everyone is going to be on a cash basis, but some are on accrual. The difference is, on a cash basis, you claim the income when you receive it (when you have possession of the funds). You claim the expenses when you pay for them. So when you use the debit card when you write the check, that is when those items are listed on the profit and loss statement. 

The accrual method is completely different. You actually are going to claim the revenue when you earn it or send the invoice. You will then include your expenses when you incur them, not necessarily when you pay them. One type of industry we use the accrual method of accounting for is construction clients. When they send the invoice to their customer/client, they actually pick up the revenue on their profit and loss right then. But then all the expenses for the job, even if they haven't paid for them yet, will be included as expenses on their profit & loss statement. 

I understand that reviewing your profit and loss statement for the first time can be a little overwhelming. Here are a few tips for you:

The first tip, which I've already reviewed a little bit above, is breaking out sales by type of service to see where your money is coming from, and the same for your expenses. You don't have to lump everything together. You can break it out so that you can see what's in your different categories. 

Then also I want you to pay attention to the profit and loss statement when it comes to things that are going on in your business. So if you're running a marketing promotion, then pay attention to the sales during that particular period of time. Did they go up? Is the marketing actually working? Is it doing what you paid for it to do? Maybe you are in a business that is seasonal, and so you need to pay attention to those trends. Are you selling more products in certain months of the year versus other months? You also need to look at year versus year or month versus month, quarter versus quarter. That's very important when you go to start analyzing your profit and loss statement - you need to have something to compare it to. 

You also should know certain percentages or KPIs (Key Performance Indicators) within your industry. For example, going back to that restaurant, if you're a restaurant owner, you should know what percentage of your cost of goods should be, what your food cost should be. You should know what those percentages, so that when you look at your profit and loss statement and you look to see - oh my goodness, my food cost is 70% of my sales - well, knowing your KPIs, you know that’s really high. And now I know where to concentrate. Look at that profit and loss statement and see if there's any major red flags going on in the operations of your business. 

As I've said before, your business books, your bookkeeping, your finances, tell the story of your business. Your profit and loss is the main attraction, right is the summary of everything going on. So if you can pull one report, this is only the report that I would tell you to pull because things should just jump off the page at you to say, “This is where my money is going. This is where my weakness is, or the opposite - wow, that's a great return on my investment.” 

For example, I spent so much in marketing this month, and my sales boosted 300% Right, but you don't know that you can feel it in your gut, you can see the sales coming through, but the profit and loss gives it to you in black and white. Know your costs for items in your industry. Know what your utility should run, you know what rent is in your area, or in your industry. Know what payroll costs should be. Those are things that you should monitor every single month. 

Remember, it's not just about wanting that positive net income. That's great and we all want that number, but it's all about figuring out what's working and what's not working. And you can find all of that on your profit and loss statement. 

So one other quick thing is I want to bring up a few misconceptions about our profit and loss statements, mistakes that I see all the time with statements that come to me from other bookkeepers sometimes where people are trying to DIY their own books. 

Number one is payments on items such as cars, furniture, equipment, things that you're financing will never ever show up on a profit and loss statement. Those things actually belong on a balance sheet. Another thing that happens is payments to yourself, unless you're on payroll, will never show up on a profit and loss statement. Those payments will actually show up on your cash flow statement. So if we're talking about the profit and loss statement, make sure there are no loan payments showing up there and there are no payments to yourself showing up. 

It's important to have a bookkeeper that is proactive and can explain these reports to you. They can give you analysis, which takes all the guesswork out of your finances.

I have a few options for you.

If you want to DIY, which I don’t recommend but I do have a Calculated  Tax Planner, which is amazing. It will help you reconcile your statements each month making sure you're picking up all the transactions from your bank, it will give you a P&L summary, and also a cash flow summary, so that helps you if you’re still wanting to try the DIY route. 

I also have two different proactive bookkeeping packages for you:

One that is simply for compliance. You just want to see the P&L, you're gonna take the data yourself and analyze it. It's for compliance, meaning you're ready for tax time. 

Then we have more of our CFO services and this is my favorite, this is my jam, I love looking at profit and loss statements, looking at cash flow statements, and really giving you an analysis on your business. Because the truth is, your profit and loss statement could show that your business is making a lot of money. But your bank account can be in the negative or very low every month. The difference is, that the profit and loss statement does not show everything coming in and out of your bank account. The cash flow statement does, and that's the difference that will help you to really understand what's going on in your business so that you can make calculated decisions based on real data. 

So either way I highly encourage you to not wait. Either start DIYing your business or book a call so that we can help you get on track and launch your business so that you can start really growing and scaling your company.