Accounting
Understanding Profit & Loss Statements
Understanding Profit & Loss Statements
The profit & loss statement (P&L) is one of the three main financial statements that companies use to analyze business performance. It provides a snapshot of a business’ profit and loss by summarizing its revenue, cost of goods sold, and expenses during a specific time period (usually monthly, quarterly or annually). Below we’ll briefly summarize the different types of P&L’s, the general components that make a P&L, and why P&L’s are important.
Cash Vs. Accrual Methods
- The cash method is a simple approach to composing a P&L. Transactions are recorded only when they clear the bank or credit card accounts. Sales and expenses are recognized at the point at which it goes in or out of the business. For example, a phone bill is not recorded as an expense until it has been paid.
- On the other hand, the accrual method defines revenue and expenses when they are incurred. Simply put, whenever services are provided or received it is recorded in a company’s books.
What Makes Up a P&L Statement
- Revenue – Revenue consists of gross sales. The net revenue is calculated by deducting any returns/discounts given.
- Cost of Goods Sold (COGS) – COGS are any expenses that are directly related to making the product that is being sold.
- Gross Profit – Gross profit = (Net Revenue – COGS)
- Operating/Non Operating Expenses – This category catches the other expenses that are incurred by running the business. This includes utilities, phone, rent, etc.
- Net Income – Net income is the gain or loss that a company makes after all sales costs & expenses have been accounted for.
Why P&L’s are Important
- Objectivity – The P&L provides objective data on performance. It allows businesses to tangibly see sales, costs, and expenses in a digestible format. Reliable data sets the foundation for useful analysis and improvement.
- Comparison – Comparing different time periods is a valuable tool in growing the business. While each year/period may come with its own hurdles, comparing different periods helps see what worked and what did not. Comparison adds a layer of context to the data being analyzed.
- Decision Making – P&L’s provide a wide view packed into one document. This allows businesses to do their best to make informed decisions. Do we need to cut costs? Increase revenue? What decisions need to be made to grow? At that level of decision making, it’s helpful to see how data relates to performance.
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Thanks for reading!
The QBcure Team
