Accounting, Thought Leaders

Understanding a Profit & Loss Statement for Your Business

February 25, 2020

by Janet Berry-Johnson

Want to know if your business is profitable? Use a Profit and Loss statement, which summarizes your business’s revenues, costs, and expenses for a specific period of time.

 

Updated March 22, 2022

Most small business owners don’t do much with their Profit and Loss Statement beyond glancing at the bottom line because they don’t know what it’s telling them. That’s understandable. Financial statements aren’t exactly intuitive to the untrained eye.

In this article, we’re going to train you to understand and read a Profit and Loss Statement, just like one of our Bench bookkeepers. 

Interested in leveraging more accounting statements for your business success? Reach out to an expert today! 

What You Should Know About Your Small Business’ Profit and Loss Statement 

  1. What is a Profit and Loss Statement
  2. Practical Things a Profit and Loss Statement Can Show You
  3. Small Business Profit and Loss Statement Elements

What Is a Profit and Loss Statement?

The Profit and Loss Statement (P&L) is also known as the Income Statement. It’s one of the three primary financial statements, along with the Balance Sheet and Statement of Cash Flows.

The P&L summarizes your business’s revenues, costs, and expenses for a specific period (and yes, there’s a difference between costs and expenses!). A P&L might cover a month, a quarter, or a year. Sometimes, it will also compare one period with an earlier period to see how you’re tracking over time.

A P&L essentially tells you if your company is profitable.

Practical Things a Profit and Loss Statement Can Show You

You can use a Profit and Loss Statement to help you decide:

Essentially, a Profit and Loss Statement can provide insight on your revenues and expenses that may not be apparent until you see them summarized in black and white. But to get there, you need to know how to read it.

Small Business Profit and Loss Statement Elements

Every Profit and Loss Statement contains four basic components:

Now that you know the four basic components, every P&L follows the same simple formula:

Revenues – Costs – Expenses = Net Income or Loss

Example of Profit and Loss Statement for Small Businesses 

Let’s look at a P&L for Blake’s Brake Repair, a fictional company, to see what that might look like in the real world.
Profit and Loss statement

The image above is just one kind of P&L Statement. The P&L from your company may look different from this one because:

Don’t let these differences throw you. The P&L may look more complicated, but if you remember that every P&L follows the same basic formula, you’ll know how to read it.

How to Analyze a Profit and Loss Statement

Knowing that Blake posted a profit in November and that he made more this November than a year ago is useful. But where a P&L really comes in handy is using the information it contains to evaluate the financial strength of the company.

Use a P&L to:

  1. What is a Profit and Loss Statement
  2. Calculate Metrics
  3. Compare Your Numbers or Metrics to Industry Benchmarks

1. Compare Month-Over-Month or Year-Over-Year Numbers

For example, looking at the P&L above, we see that Blake posted a profit of $25,000 for the month of November 2019 compared to a profit of $19,000 for the same period in 2018.

That’s good news! However, Blake could also look at each number, line-by-line, to look for variances.

For example, revenues increased while the cost of goods sold decreased. Typically, when sales go up, so do direct costs. So why are costs down? Maybe Blake negotiated a better deal with his parts supplier, so the variance makes sense. But if the difference is surprising, Blake might want to investigate the reason.

2. Calculate Metrics

Metrics are a good way to objectively track the health of your business. Here are three that you can calculate using a Profit and Loss Statement and how that would look for Blake’s metrics.

Gross Profit Margin

Gross profit margin indicates how much of your revenue is profit after factoring in direct costs.

Gross profit margin = (revenue – cost of goods sold) / revenue

For example, if Blake wanted to calculate his metrics for November 2019 based on the P&L above, his results would look like this:

($105,000 - $12,000) / $105,000 = 89%

Net profit margin

Net profit margin tells you what percentage of your revenue was profit. Unlike the gross profit margin, it takes into account all expenses, not just direct costs.

Net profit margin = (revenue – costs – expenses) / revenue

You can use this formula and the P&L statement to calculate Blake’s net profit: 

($105,000 - $12,000 - $68,000) / $105,000 = 24%

Operating Expense Ratio

Operating expense ratio tells you what percentage of your revenues goes toward paying expenses other than direct costs.

Operating expense ratio = total operating expenses / revenues

For example:

$68,000 / $105,000 = 65%

Looking at the metrics above, Blake can see that 89% of his revenue is profit after paying direct costs, 24% of his revenues are profit after taking into account all costs and expenses, and 65% of his revenues go toward paying operating expenses.

3. Compare Your Numbers or Metrics to Industry Benchmarks

Knowing your own numbers and metrics is useful, but how do you compare to the competition? Industry benchmarks can provide an answer.

Benchmarks are industry standards that represent the average of key numbers collected from many different businesses in your industry. They’re an excellent tool for measuring your company’s performance against similar businesses.

Once you’ve calculated metrics for your company, compare them to the standards in your industry. If your ratios are pretty close to or better than industry benchmarks, you know you’re on the right track. If not, you may want to dig into the reasons your results are different and perhaps consider changes in how you run your business.

You can usually find benchmarking data through a national industry association, your local chamber of commerce, or even the U.S. Census.

A Profit and Loss Statement Can Help You Understand Your Small Business

If you’ve been filing your Profit and Loss Statements away without reading them, it may take a while to get comfortable reviewing the numbers. Once you do, however, you’ll realize your P&L is a useful tool for running your business successfully.

Are you looking for an experienced bookkeeper? Check out our shortlist of top agencies on our directory page

Additional Reading

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