Understanding Financial Statements - Income Statement (P&L)
Small business accounting requires much more than developing financial statements for review, but these statements when information is recorded correctly can show….
The financial position of a business
The results of operations for a specific time period
Statistical information such as the best-selling item or gross profit margin
Information about customers, vendors, and employees
But first, you need to understand the two basic forms of accounting, and whichever one you employ will determine how the income statement is reviewed.
Cash-basis reports
A Cash -basis accounting system reports cash flow as it comes in and as it goes out. That means as you receive cash, checks, or credit card payments, the revenue is reported the day it was received. All expenses are recorded as they are paid.
This is probably easiest to understand because it is basically like managing your checkbook ledger. When you get paid or deposit money into your account you add that to your ledger, and when you write out a check to pay the electric or use your bank card to purchase something you report it to the ledger.
Although this is an acceptable accounting practice for small businesses, it is probably not the most efficient to grow your business and keep track of any receivables or expenses. But with that said, most accounting systems will allow you to print the report in various ways no matter what system of accounting you are using. Printing a report on a cash-basis will provide you a quick overview of your cash flow.
Accrual-basis reports
These reports display income at the time it was invoiced and expenses at the time they were purchased, regardless of when the payment occurred. This system records and tracks all your receivables and bills payable which allows you to better budget yourself and account for the cash flow.
The P&L Report?
The profit and loss statements contain summarized information about revenue and expenses. Based on the standard operating procedure of a business, these statements can be generated on a weekly, monthly, quarterly or annual basis.
The basic formula of a P&L report is:
Revenue – Expenses = Profits
What Does the Profit and Loss Statement Show?
The profit and loss report is an important financial statement used by business owners and accountants. The report shows information about the net profit based on your revenues and expenses. It details the ability of a business to manage its profits by cutting costs and driving revenue.
The P&L report also allows you to investigate revenue and expense trends, cash flow, net income, and overall profitability – to then allocate resources and budgets accordingly.
The P & L is very similar to the information that is needed on your business portion of your tax returns which determines how much money is owed or refunded.
Components of a Profit and Loss Report
Revenue: This entry represents the net sales or turnover during the accounting period. It includes the revenue earned from the primary business activity of the entity along with the non-operating revenue and gains on the sale of long-term business assets.
Cost of Goods Sold: It represents the cost of products and services.
Gross Profit: Also known as gross income or gross margin, the gross profit is net revenue excluding costs of sales.
Operating Expenses: Operating expenses are administrative, general, and selling expenses that are related to running the business for a specific period of time. This includes rental expenses, payroll, utilities, and any other expense required to operate the business. Also included are non-cash expenses such as depreciation.
Operating income: It refers to earnings before taxes, depreciation, interest, and authorization. Deduct operating expenses from your gross profit to calculate operating income.
Net Profit: It is the total amount earned after deducting the expenses. To calculate net profit, subtract the total expenses from your gross profit.
HOW TO CALCULATE PROFIT
To find the net profit (or net loss) of your business, here are a few simple steps.
Gross Profit = Net Sales – Cost of Sales
Net Operating Profit = Gross Profit – Operating Expense
Net Profit before Taxes = Net Operating Profit + Other Income − Other Expense
Net Profit (or Loss) = Net Profit before Taxes − Income Taxes
PROFIT AND LOSS REPORT SAMPLE
A P&L starts with a header that contains the name of your business and the accounting period.
This is followed by:
Income
Expenses
Net Profit
Example profit and loss statement
Total revenue $1,000,000 100%
Cost of Goods Sold (less) $ 426,200 42.6%
Gross Profit $ 573,800 57.4%
Expenses
Accounting and legal fees $ 11,700
Advertising $ 15,000
Depreciation $ 38,000
Electricity $ 2,700
Insurance $ 15,200
Interest and bank charges $ 27,300
Postage $ 1,500
Printing and stationery $ 8,700
Professional memberships $ 1,800
Rent for premises $ 74,300
Repairs and maintenance $ 21,100
Training $ 6,900
Vehicle operating costs $ 20,000
Wages and salaries $ 223,500
Workers compensation $ 6,500
All other expenses $ 14,100
Total Expenses $ 488,300 48.8%
Net Profit (BOS) $ 85,500 8.6%
BOS = Before owners salary
The above income statement shows the various expenses, income, and net profit. Although this gives you an idea about the goings-on of the business, and if reviewed regularly you will be able to locate areas where there may be something wrong. This statement should just be a review because it will not expose problems until they reach an excessive level or you may never foresee the problem s at all.
This statement, however, is important for lenders, investors, and others who may have an interest in the company. Although they may review the entire document to see how and where the money is expensed, their biggest interest is the bottom line.
Many small business owners become frustrated because they try to get a low-interest bank loan or Line of Credit, and are consistently denied. The reason for this is that their financials are not acceptable, mostly because they show a loss to pay no tax. Lenders look at the profit of the company to figure out the loan amount and payment the business can afford. Showing a loss shows that the business can not handle more debt.
In our next article, we will review the Balance Sheet. As we move through the series we will try to dive deeper into what is needed from an accounting standpoint to get into the nuts and bolts of the cash that comes in and what goes out. Having the right accounting support will help you grow your business, provide you a deep understanding at your fingertips while providing you the freedom to concentrate on the growth of the business.
Contact Ebizmore Accountants and Advisors for a free analysis on how they can save you money, build profits and help you reach your goals. Ready? Contact us at accounting@ebizmore.com or visit us at https://ebizmore.org/