Profit and loss statement: Definition and how to create one

A profit and loss statement, often called a P&L, summarizes your revenues, costs, and expenses to calculate profit or loss. It’s also known as an income statement, and it works alongside your balance sheet and cash flow statement to give you a complete view of your business’s performance.

If you want to run a healthy business, you need to know whether you’re actually making money. A P&L shows exactly how your company performed over a specific period, so you can manage based on data instead of guesswork.

What is a profit and loss statement?

A profit and loss statement is a financial report that shows how much money your business earned and spent during a specific period, such as a month, quarter, or year. It starts with revenue, subtracts costs and expenses, and ends with net profit or loss. In simple terms, it answers one question: Did your business make money?

You might also hear a P&L called an income statement, statement of operations, or earnings statement. Regardless of the name, the purpose is the same. It helps you track performance over time and understand where your money comes from and where it goes.

Unlike other financial statements, a P&L focuses on activity during a period rather than a single point in time. It doesn’t show what you own or owe. That distinction matters when you’re analyzing performance.

P&L statement vs. balance sheet

A P&L statement shows performance over time, while a balance sheet shows your financial position at a specific moment. The P&L tracks income and expenses and ends with profit or loss. The balance sheet lists assets, liabilities, and equity.

You’ll see revenue, cost of goods sold (COGS), and operating expenses on a P&L. On a balance sheet, you’ll see:

• Cash
• Accounts receivable
• Loans
• Retained earnings

Together, these statements explain both how your business performed and where it stands financially.

P&L statement vs. cash flow statement

A P&L statement records revenue and expenses based on accounting rules, often using accrual accounting. A cash flow statement tracks actual cash moving in and out of your business. Looking at only one can lead to misleading conclusions.

You need both to get a complete picture. Your P&L might show a profit while your cash flow statement reveals a cash crunch. Reviewing them together helps you avoid surprises and plan more effectively.

Why your business needs a P&L statement

A P&L statement isn’t just for accountants or tax season. It’s a core management tool that supports everyday decisions. Many businesses are legally required to maintain financial records, and P&Ls are often needed for tax filings and audits.

Lenders and investors rely on P&L statements to evaluate profitability and risk. If you’re applying for financing, a clean and accurate P&L can make or break the process. Internally, it helps you spot trends, test assumptions, and course-correct early.

Key benefits for small business owners

As a small business owner, a P&L statement can help you:

• Identify profitable vs. unprofitable products or services: Compare revenue and costs by category to see which offerings drive profit and which drain resources
• Spot expense reduction opportunities: Clear expense visibility makes inefficiencies easier to identify and address
• Make informed pricing decisions: Understanding your margins shows how much room you have to adjust pricing or absorb cost increases
• Plan for growth and expansion: Historical P&Ls reveal whether growth is sustainable and help you forecast future performance and budget for hiring or new investments

Profit and loss statement components

Every P&L statement follows the same basic structure. It starts with revenue and moves step by step toward net profit. Understanding each component helps you build and analyze your statement accurately.

1. Revenue or sales

Revenue, often called the top line, is the total income your business earns during the reporting period. It includes all money generated from selling products or services before expenses are deducted. Accurate revenue tracking is critical because every other calculation depends on it.

You might include these types of revenue:

• Operating revenue: Income from your core business activities, such as product sales or service fees
• Non-operating revenue: Income from secondary sources, such as interest, rental income, or asset sales

Group similar income streams together to improve clarity. Consistent categories make it easier to compare periods and spot trends.

2. Cost of goods sold

Cost of goods sold (COGS) represents the direct costs required to produce your products or deliver your services. It typically includes materials, direct labor, and production-related expenses. Subtracting COGS from revenue gives you gross profit.

To calculate COGS, consider:

• Direct materials and labor: Costs directly tied to production, such as raw materials or wages for production staff
• Manufacturing overhead: Indirect production costs like equipment depreciation or factory utilities
• Service business considerations: Labor and project-specific costs tied directly to delivering client work

3. Gross profit

Gross profit shows how efficiently your business produces goods or services before operating expenses.

Gross profit = Revenue – COGS

Gross profit margin, calculated as gross profit divided by revenue, helps you compare performance across periods.

A healthy gross profit indicates that pricing and production are aligned. If gross profit shrinks, it’s often a sign of rising costs or underpricing.

4. Operating expenses

Operating expenses cover the costs of running your business that aren’t directly tied to production. These expenses support daily operations and are subtracted from gross profit to calculate operating income.

Common operating expense categories include:

• Selling expenses: Marketing, advertising, and sales commissions
• Administrative expenses: Rent, utilities, and administrative salaries
• General expenses: Insurance, legal fees, and professional services

5. Net profit

Net profit, or the bottom line, is what remains after all expenses are subtracted from revenue. It reflects overall profitability for the period. Net profit differs from gross profit because it accounts for operating expenses, interest, and taxes.

A positive net profit means your business earned more than it spent. A loss signals the need for changes in pricing, costs, or strategy.

How to create a profit and loss statement step by step

Building a P&L statement doesn’t have to be complicated. A structured process helps you maintain accuracy and consistency. These steps work whether you’re using a spreadsheet or accounting software.

Step 1: Select your reporting period

Choose whether your P&L will cover a month, quarter, or year. Monthly statements help you monitor margins closely, while annual statements support tax filing and strategic planning. Pick a period that aligns with how often you make decisions.

Sample choice:

• Reporting period: January 1–31

If you run this monthly, you’ll spot margin changes faster than if you only review quarterly or annually.

Step 2: Gather financial documents

Collect invoices, receipts, bank statements, and payroll records. Complete and organized records reduce errors and save time. Good bookkeeping makes every step easier.

Example checklist:

• Sales invoices or point-of-sale reports
• Payment processor reports, such as credit card or ACH
• Bank statements
• Vendor bills and receipts
• Payroll reports
• Inventory records

Sample totals you’ll use later:

• POS report shows $52,000 in gross sales
• Returns report shows $1,200 in returns
• Discount report shows $800 in discounts
• Vendor bills show $18,500 in inventory purchases
• Payroll report shows $9,000 in wages

Step 3: List all revenue streams

Add up all income earned during the period. Separate operating and non-operating revenue for clarity. Subtract returns, refunds, and discounts to reflect net revenue.

Sample revenue calculation:

• Product sales: $52,000
• Service revenue: $8,000
• Total gross revenue: $60,000

Adjustments:

• Returns: $1,200
• Discounts: $800

$60,000 – $1,200 – $800 = $58,000

If you have non-operating revenue, such as interest income, list it separately:

• Interest income: $100

Step 4: Calculate cost of goods sold

For product businesses, use beginning inventory plus purchases minus ending inventory. For service businesses, include labor and direct project costs tied to delivering client work. The goal is the same: capture the direct costs required to generate revenue.

Inventory-based formula:

COGS (inventory) = Beginning inventory + Purchases – Ending inventory

Sample inventory calculation:

• Beginning inventory: $12,000
• Inventory purchases: $18,500
• Ending inventory: $10,500

$12,000 + $18,500 – $10,500 = $20,000

Add other direct costs:

• Direct production labor: $3,000
• Freight-in: $500

$20,000 + $3,000 + $500 = $23,500

Step 5: Determine gross profit

Subtract COGS from revenue to calculate gross profit. This shows how efficiently you deliver your product or service.

Gross profit = Net revenue – COGS

$58,000 – $23,500 = $34,500

Gross profit margin:

Gross profit margin = Gross profit / Net revenue

$34,500 / $58,000 = 59.5%

If this margin drops month to month, rising costs or discounting may be the cause.

Step 6: List operating expenses

Group expenses into categories such as selling, administrative, and general. Include both fixed and variable costs.

Sample totals:

• Selling expenses: $3,500
• Administrative expenses: $3,850
• General expenses: $1,400
• Administrative payroll: $6,000

$3,500 + $3,850 + $1,400 + $6,000 = $14,750

Step 7: Calculate operating income

Operating income equals gross profit minus operating expenses. You may also see EBITDA used to exclude depreciation and amortization.

Operating income = Gross profit – Operating expenses

$34,500 – $14,750 = $19,750

Step 8: Include other income and expenses

Add items such as interest income, interest expense, and one-time gains or losses. Keep these separate from core operations.

Sample adjustments:

• Interest income: +$100
• Interest expense: –$350
• Equipment write-off: –$200

$100 – $350 – $200 = –$450

Income before taxes:

Income before taxes = Operating income + Other income or expense

$19,750 – $450 = $19,300

Step 9: Calculate net profit

Subtract taxes from income before taxes to determine net profit or loss.

Net profit = Income before taxes – Taxes

$19,300 – $3,800 = $15,500

Net profit margin:

Net profit margin = Net profit / Net revenue

$15,500 / $58,000 = 26.7%

A rising net margin can signal stronger pricing or tighter expense control. A falling margin may indicate overhead growth, higher interest costs, or tax changes.

Example multi-step profit and loss statement

Here’s how the completed example would look in a standard multi-step P&L format:

This layout makes it easier to see how revenue flows through each stage of the income statement, from top line to bottom line.

Types of P&L statements

Not all P&L statements look the same. The format you choose depends on your business size, complexity, and reporting needs.

Single-step P&L statement

A single-step P&L groups all revenues together and subtracts all expenses in one calculation. It’s simple to prepare and easy to read, which makes it common among small businesses with straightforward operations.

This format works well for freelancers, early-stage startups, and small service businesses. While it doesn’t provide detailed margin insights, it still answers the core question: Did you make money during the period?

Multi-step P&L statement

A multi-step P&L separates operating and non-operating activities. It breaks out gross profit, operating income, and net profit as distinct steps, giving you clearer visibility into performance.

Product-based businesses and larger companies often use this format because it highlights cost structure and operating efficiency. Investors and lenders also prefer it since it shows how profitable your core operations are before financing and tax effects.

Cash vs. accrual method

Cash-based P&L statements record income and expenses only when cash changes hands. This approach is simple but can distort performance if invoices or bills span reporting periods.

Accrual-based P&Ls recognize revenue when earned and expenses when incurred, regardless of payment timing. This method provides a more accurate picture of profitability and is required for many growing businesses.

P&L statement templates and tools

Templates and software can save time and reduce errors when preparing your P&L. Many free spreadsheet templates for income statements are available online, and accounting software automates calculations and updates statements in real time.

As your business grows, professional help may also make sense. An accountant can help ensure compliance and provide deeper analysis, while automation reduces manual work.

Profit and loss statement template structure

Below is a standard multi-step P&L layout you can use as a starting point:

Recommended software solutions

QuickBooks, Xero, and FreshBooks all offer P&L reporting. Look for features like bank integrations, expense categorization, and real-time reporting. Integration with spend management tools can improve accuracy and speed.

How to read and analyze your P&L statement

Your profit and loss statement tells the story of your business’s financial performance over a specific period. It shows whether you’re making money, where that money comes from, and where it goes.

Reading the results

Start at the top and work your way down. Revenue appears first, followed by expenses that reduce it step by step until you reach net profit. This structure shows how efficiently your business turns sales into actual earnings.

Compare current results to previous months, quarters, or years. Seasonal swings may be normal, but sharp changes deserve attention. Consistent trends tell you more than any single month ever will.

Key metrics that matter most

While every line item matters, three core metrics give you the clearest view of performance:

1. Gross profit margin
2. Net profit margin
3. Expense ratios

These ratios help you benchmark performance and make informed decisions about pricing, spending, and growth.

Gross profit margin

Gross profit margin measures how much revenue remains after paying direct production costs.

Gross profit margin = (Gross profit / Total revenue) * 100

Higher margins generally indicate stronger pricing power or better cost control, though healthy ranges vary by industry.

Net profit margin

Net profit margin shows what percentage of revenue becomes profit after all expenses.

Net profit margin = (Net income / Revenue) * 100

This metric reflects overall profitability and operational discipline. Software companies, for example, typically report higher margins than retail or manufacturing businesses.

Expense ratios

Expense ratios show how much of your revenue goes toward specific categories such as marketing or administrative costs.

Expense ratio = (Specific expense category / Total revenue) * 100

Rising ratios can signal inefficiencies, but context matters. Some increases reflect strategic investments rather than operational problems.

Spotting trends and red flags

Look for patterns across multiple periods. Revenue growth paired with shrinking margins may signal rising costs or pricing pressure. Stable revenue with improving margins usually indicates stronger cost control.

Declining gross margins over time can point to supply chain issues or competitive pressure. Rising overhead without revenue growth often signals operational bloat. On the other hand, consistent profitability across periods suggests a resilient business model.

Finding improvement opportunities

Your P&L highlights where you can improve performance.

• Compare expense ratios to industry benchmarks when available
• Focus on revenue streams with the highest margins
• Separate one-time expenses from ongoing operational costs
• Align spending with seasonal revenue cycles

Regular monthly reviews help you identify issues early and scale strategies that are working. The more consistently you analyze your P&L, the faster you’ll spot both risks and opportunities.

Profit and loss statement vs. other financial statements

Your profit and loss statement doesn’t stand alone. It works alongside your balance sheet and cash flow statement to give you a complete view of your company’s financial health.

Profit and loss statement

A P&L focuses on performance over time. It shows how much revenue you generated, what you spent, and whether you earned a profit or took a loss during a specific period.

This statement answers a simple but critical question: Did your business make money during the reporting period?

Balance sheet

Unlike a P&L, which measures performance across a period, your balance sheet captures your financial position at a single moment in time. It lists your assets, liabilities, and equity.

The balance sheet follows the accounting equation:

Assets = Liabilities + Equity

This formula shows how your company is financed and what it’s worth at a given point.

Cash flow statement

The cash flow statement tracks how cash moves in and out of your business across three categories:

1. Operating activities
2. Investing activities
3. Financing activities

You can be profitable on paper and still run into cash flow problems. This statement shows whether you have the liquidity to meet your obligations.

How they work together

Each statement fills in the others’ blind spots. Your P&L may show strong profits, while your balance sheet reveals heavy debt. Or your P&L may show steady income, while your cash flow statement highlights slow customer payments.

Together, these three reports provide a comprehensive view of performance, stability, and liquidity, helping you make informed decisions about your business’s future.

Common P&L statement mistakes to avoid

Even a well-formatted P&L can lead to poor decisions if it’s built on flawed inputs. Most problems don’t stem from complex accounting rules, but from small habits that gradually distort your numbers.

Avoiding these mistakes improves consistency, strengthens trend analysis, and reduces surprises at tax time or during financing discussions. The goal isn’t perfection — it’s clarity and reliability over time.

Mixing personal and business expenses

Combining personal and business spending makes your P&L unreliable. It inflates expenses, distorts margins, and creates tax complications. Even small personal charges can hide real performance issues.

Keeping expenses separate also protects you during audits and due diligence. Dedicated business accounts and cards make separation easier and your financial data cleaner.

Incorrect expense categorization

Misclassifying expenses can make your margins look better or worse than they really are. For example, recording production labor as an operating expense instead of COGS understates gross profit. These errors undermine meaningful comparisons over time.

Consistency matters more than perfection. Once you establish a structure, apply it consistently so trends remain reliable.

Timing issues with revenue recognition

Recording revenue too early or too late can misrepresent performance. This often happens under accrual accounting when invoices and payments don’t align. Clear revenue recognition policies help prevent distortion. Align your reporting with how your business actually earns revenue and apply your rules consistently.

Forgetting to include all revenue sources

Smaller revenue streams, especially non-operating income, are easy to overlook. Over time, those omissions can understate performance and skew ratios. Listing revenue categories in advance helps prevent gaps. Reviewing bank deposits against recorded revenue is a simple way to catch missing income.

Not reconciling with bank statements

If your P&L doesn’t reconcile with your bank activity, something is wrong. Duplicate entries, missing expenses, or timing errors are common causes. Regular reconciliation keeps your P&L grounded in reality and builds confidence in your numbers for planning, financing, and reporting.

Improve P&L accuracy and analysis with Ramp

Creating accurate P&L statements requires clean data, proper categorization, and constant reconciliation, draining hours of your team's time every month. Ramp's accounting automation software eliminates manual work by coding transactions in real time, syncing spend automatically, and generating reports that reflect your financial position instantly.

Ramp's AI learns your accounting patterns and codes every transaction across all required fields as it posts, so your revenue and expense categories stay accurate without manual intervention. When transactions need review, Ramp flags them with context and suggested actions, so you spend less time hunting for details and more time analyzing what matters.

Here's how Ramp streamlines P&L creation and analysis:

• Real-time transaction coding: AI applies your feedback to code spend across custom fields instantly, so categories stay consistent
• Automated ERP sync: Routine, in-policy transactions post to your accounting system automatically, eliminating manual entry and reducing coding errors
• Built-in reporting: Generate P&L statements on demand with real-time data, so you can analyze performance trends, spot anomalies, and make decisions faster
• Audit-ready documentation: Every transaction includes receipts, approvals, and context, so variance analysis is straightforward and explanations are always at hand

Try a demo to see how Ramp helps finance teams create more accurate P&L statements in minutes, not days.