How to create and analyze a profit and loss statement

A profit and loss statement, often called a P&L or income statement, is your business's financial report card. It shows how much money your company brought in, what it spent, and whether you made a profit or took a loss over a given period, typically a month, quarter, or year.

This financial snapshot serves as one of your most valuable business tools. It reveals which parts of your operation are generating the most revenue, where your biggest expenses lie, and whether your business is trending in the right direction. Armed with this information, you can make smarter decisions about pricing, spending, and growth opportunities.

In this guide, we'll cover how to make a profit and loss statement step by step, why it's important, how to analyze it, and how it compares to other financial documents.

What is a profit and loss statement?

A profit and loss (P&L) statement summarizes a company's total revenue, expenses, and net income over a specific period to assess profitability and financial health. P&L statements typically cover monthly, quarterly, or annual accounting periods.

The profit and loss statement is also known as:

• Income statement: A common alternative, especially in formal accounting and financial reporting
• Profit and loss report: Another variation that emphasizes the document's role as a business report, often used interchangeably with P&L statement
• Statement of operations: Used particularly by larger corporations and in official financial documents
• Statement of earnings: Another formal variation you'll encounter in corporate reports
• Revenue statement: Less common but still used, focusing on the revenue aspect
• Statement of financial performance: More formal terminology often seen in international accounting standards
• Earnings statement: Similar to statement of earnings, emphasizing the profit/earnings focus

The terms P&L and income statement are the most widely recognized, so those in the know will understand what you mean regardless of which one you use. Different industries and regions may favor certain terms, but they all refer to the same fundamental document that tracks your revenues, expenses, and bottom-line results.

The P&L statement is one of the big three financial statements that every business needs to prepare. While your P&L shows your profitability over time, your balance sheet captures what you own and owe at a specific moment, and your cash flow statement tracks how money moves in and out of your business. Together, these three documents provide a complete financial picture.

Why the profit and loss statement matters

A P&L statement serves as your business's financial snapshot, showing exactly how much money you're making or losing over a specific period. For businesses of any size, this document reveals whether your operations are profitable, highlights areas where you might be overspending, and uncovers growth opportunities you may have missed.

Beyond tracking current performance, your P&L becomes essential for creating realistic budgets and forecasting future revenue. When you're seeking funding, investors and lenders rely heavily on P&L statements to evaluate your business's financial health and potential.

This document tells the story of your company's financial performance, making it an important tool for smart business decisions and long-term planning.

Single-step vs. multi-step profit and loss statements

There are two primary formats for P&L statements: single-step and multi-step. Choosing the right format depends on your business’s complexity and reporting needs.

Single-step

A single-step profit and loss statement is a simplified financial report that uses a basic formula to calculate net income:

Net income = Total revenue – Total expenses

This simpler method groups all revenues and gains together and subtracts all expenses and losses in a single step. Naturally, its straightforward nature offers both pros and cons.

Pros:

• Simple to prepare: Requires minimal accounting knowledge. You can create a single-step P&L quickly by totaling all revenues and subtracting all expenses in one calculation.
• Easy to understand: Straightforward format makes it accessible for business owners, investors, and stakeholders who need a fast overview of profitability
• Cost-effective: Reduces accounting time and expenses since it doesn't require detailed categorization of income and expenses

Cons:

• Limited detail: Doesn't break down operating vs. non-operating expenses, making it harder to identify specific problem areas or growth opportunities
• Poor decision-making tool: Lack of expense categories prevents managers from analyzing which business areas are most or least profitable
• Inadequate for complex businesses: Companies with multiple revenue streams or diverse operations need more detailed analysis that single-step statements can't provide

Overall, a single-step P&L statement is best for small businesses or companies with straightforward financial structures.

Multi-step

A multi-step P&L statement separates operating and non-operating activities, providing detailed insights into gross profit, operating income, and net income. Larger businesses or those needing deeper financial analysis prefer this format. Like the single-step P&L, it also has its pros and cons.

Pros:

• Detailed analysis: Separates operating income from non-operating activities, allowing managers to evaluate core business performance versus one-time gains or losses
• Better decision-making: Breaks down gross profit, operating and non-operating expenses, and other categories, making it easier to identify which areas need improvement or investment
• Professional credibility: Provides a comprehensive format that investors, lenders, and stakeholders expect from established businesses

Cons:

• Time-intensive preparation: Requires more detailed bookkeeping and categorization of revenues and expenses, increasing your accounting workload
• Higher complexity: Can overwhelm small business owners or those without financial backgrounds who just need basic profitability information
• Increased costs: May require professional accounting services or more sophisticated software to prepare accurately and consistently

If your business has multiple revenue streams, significant expenses, or external investments, a multi-step statement can provide clearer insights.

Cash vs. accrual accounting

Your choice between cash and accrual accounting methods significantly impacts how your P&L statement looks and when you record transactions.

With cash accounting, you only record revenue when payments actually hit your bank account and expenses when you pay them. This means if you invoice a client in December but don't receive payment until January, that sale shows up on next year's P&L statement. Similarly, expenses you haven't paid yet won't appear, even if you've already received the goods or services.

Accrual accounting takes a different approach by recording transactions when they occur, regardless of when money changes hands. That December invoice appears on December's P&L statement, and unpaid bills show up as expenses in the period you incurred them. This method provides a more accurate picture of your business's performance since it matches revenues with the expenses that helped generate them.

The timing difference can create dramatically different P&L results between the two methods, especially for businesses with significant receivables or payables.

How to make a profit and loss statement

Most small business owners generate their financial statements using a spreadsheet program such as Excel or accounting software such as QuickBooks. You can also follow the steps below to create one using a profit and loss statement template.

1. Gather financial data

The foundation of any reliable profit and loss report starts with collecting financial information from all areas of your business, including all revenue sources and expenses.

Some sources of revenue are:

• Sales revenue from products or services
• Interest income from investments
• Rental income from property
• Subscription or membership fees
• Consulting or professional service fees

Expenses may include:

• Cost of goods sold (COGS)
• Operating expenses (OpEx)
• Employee salaries and wages
• Benefits and payroll taxes
• Rent and utilities
• Office supplies and equipment

Accurate recordkeeping makes this process smoother and more reliable. Keep detailed records throughout the year rather than scrambling to piece together information at the last minute. Your future self will thank you for the organized approach.

2. Choose a reporting period

Decide which specific period your statement will cover, such as a month, quarter, or year. Choosing the appropriate timeframe allows you to analyze trends and make data-driven decisions.

3. Calculate total revenue

Your total revenue is all the money your business generated from core operating activities during the reporting period, before deducting any expenses. It's also known as gross revenue or sales revenue.

4. Calculate cost of goods sold

COGS includes expenditures directly related to production, such as:

• Raw materials
• Direct labor costs
• Manufacturing overhead

To separate COGS from OpEx, focus on what's directly tied to production versus what supports general business operations. For example, factory wages are COGS, while office rent is an operating expense.

5. Calculate gross profit

Gross profit shows how much money you have left after covering the direct costs of producing your goods or services. It's calculated with a simple formula:

Gross profit = Total revenue – COGS

Gross profit matters because it reveals whether your core business operations are profitable before accounting for overhead expenses such as rent, marketing, and administrative costs. A healthy gross profit margin gives you room to cover operating expenses and still generate net profit.

6. List operating expenses

OpEx are the costs of running your business that aren't directly tied to producing your products or services. These include:

• Payroll
• Rent and utilities
• Marketing and advertising
• Research and development (R&D)
• General and administrative (G&A) expenses
• Accounting software costs

The key difference from COGS is that OpEx supports your overall business operations rather than the actual creation of what you sell. While COGS fluctuates with production volume, OpEx typically remains relatively steady regardless of how much you produce.

7. Calculate operating profit

Operating profit, also called operating income, represents earnings from core operating activities before interest and taxes.

The operating profit formula is:

Operating profit = Gross profit – Total operating expenses

This figure shows how profitable your core business activities are before financing costs and taxes come into play.

8. Add or remove other income and expenses

After calculating operating profit, you'll need to account for non-operating items that affect your bottom line, such as:

• Interest income and dividends earned
• Interest expenses
• Taxes
• One-time gains or losses, such as asset sales

These adjustments give you a complete picture of your company's total financial performance beyond just operations.

9. Calculate taxes, depreciation, and amortization

The final step in calculating net profit involves making crucial adjustments that reflect the true cost of doing business and your legal obligations:

• Depreciation and amortization: Account for asset costs over time
• Income taxes: Must be deducted to determine net income

Once you have these numbers, you'll be ready to calculate your net profit or loss.

10. Calculate net profit or net loss

The final figure represents net profit, if positive, or net loss, if negative. Make sure your profit and loss statement includes all relevant income and expenses before finalizing.

The net profit formula is:

Net profit = Operating profit – Taxes – Depreciation – Interest

This final number tells you whether your business made money or lost money during the reporting period, making it the most important metric on your profit and loss statement.

Example of a profit and loss report

Let's walk through a simple example using ABC Marketing Agency, a small digital marketing firm that had a solid year. Here's how their annual P&L statement looked:

• Revenue: $100,000
• COGS: $40,000
• Gross profit: $60,000
• Total operating expenses: $35,000
• Net profit: $25,000

This gives us a clear picture of how the company performed financially, showing they kept 25% of their revenue as profit after covering all expenses.

Revenue breakdown

ABC Marketing Agency generated their $100,000 in revenue from several different service offerings throughout the year:

• Social media management retainer fees: $45,000
• Website design and development projects: $30,000
• Pay-per-click advertising management: $15,000
• Content creation and copywriting: $10,000

This diversified revenue mix helped the agency maintain steady income from both recurring monthly clients and one-time project work.

Expenses breakdown

The company's $75,000 in total expenses fell into two main expense categories: direct costs and operating expenses.

Cost of goods sold ($40,000):

• Freelancer payments for specialized work: $32,000
• Software subscriptions for client campaigns: $8,000

Operating expenses ($35,000):

• Office rent and utilities: $18,000
• Employee salaries and benefits: $10,000
• Marketing and business development: $4,000
• Insurance and legal fees: $3,000

These expenses represent the real costs of running the business and delivering services to clients.

Calculating net profit

The path from revenue to net profit follows a straightforward formula that reveals the company's true profitability.

Starting with a total revenue of $100,000:

1. We first subtract COGS ($40,000)
2. This gives us a gross profit of $60,000
3. Next, we deduct OpEx ($35,000) from the gross profit

$100,000 – $40,000 = $60,000 in gross profit

$60,000 – $35,000 = $25,000 in net profit

This calculation gives us the final net income of $25,000, which represents the actual profit the business owners can reinvest or take as personal income. This 25% profit margin indicates ABC Marketing Agency ran an efficient operation while maintaining healthy profitability.

How to analyze a profit and loss statement

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

Reading the results like a pro

Start from the top and work your way down. Revenue sits at the top, representing all the money flowing into your business. Below that, you'll see various expenses being subtracted, eventually leading to your bottom line—net profit. This cascading structure reveals how efficiently your business converts sales into actual profit.

Pay close attention to the relationship between different line items. Compare your current period's numbers to previous months, quarters, or years. Seasonal businesses might see natural fluctuations, while others should show more consistent patterns. Any dramatic changes deserve investigation.

Key metrics that matter most

While every line on your P&L statement has value, three core metrics give you the clearest picture of your business's financial health:

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

This measures how much money remains after paying for the direct costs of producing your goods or services. Calculate it by dividing gross profit by total revenue, then multiply by 100:

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

A healthy gross margin varies by industry, but higher percentages generally indicate better pricing power and operational efficiency.

Net profit margin

This reveals what percentage of your revenue actually becomes profit after all expenses. It's calculated by dividing net income by revenue, and then multiplying by 100:

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

This metric shows your overall profitability and management effectiveness. Industries such as software typically enjoy higher net margins than retail or manufacturing businesses.

Expense ratios

These help you evaluate spending patterns. Calculate these by dividing specific expense categories by total revenue and multiplying by 100.

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

Track ratios for marketing, administrative costs, and other major expense categories. Rising expense ratios might signal inefficiencies, but they could also be due to one-time investments. Context matters here.

These three metrics work together to give you a complete view of your financial performance. Track them monthly to spot trends early and make data-driven decisions about your business direction.

Spotting trends and red flags

Look for patterns across multiple periods. Revenue growth accompanied by shrinking margins might indicate pricing pressure or rising costs. Conversely, stable revenue with improving margins suggests better cost control.

Red flags include declining gross margins over time, which could signal increased competition or supply chain issues. Rising administrative expenses without corresponding revenue growth often indicate bloating. Sharp increases in any single expense category warrant investigation.

Look for positive opportunities, too. Improving margins with steady revenue growth suggests your business is becoming more efficient. Consistent profitability across different periods indicates a stable business model.

Finding improvement opportunities

Once you've analyzed your trends and metrics, the real value comes from translating those insights into improvements. Your P&L statement contains clues about where to focus your efforts for maximum impact:

• Compare your expense ratios to industry benchmarks when available: Higher-than-average spending in certain areas might reveal optimization opportunities. However, some expenses represent investments in growth, so evaluate them within the context of your business strategy.
• Analyze which revenue streams generate the highest margins: Focus on growing these profitable areas while evaluating whether low-margin activities still make sense. Sometimes discontinuing unprofitable products or services can boost overall performance.
• Consider the timing of expenses and revenue recognition: Seasonal patterns might suggest opportunities to better align costs with revenue cycles. Large one-time expenses should be identified and separated from ongoing operational costs for clearer trend analysis.

Your profit and loss report is most valuable when you review it regularly and compare results over time. Monthly reviews help you catch issues early and identify successful strategies worth scaling.

Profit and loss statement vs. other financial statements

When you're looking at your company's financial health, the profit and loss statement doesn't work alone. It teams up with two other key reports to give you the complete picture: the balance sheet and the cash flow statement.

Profit and loss statement

Focusing entirely on performance over time, the P&L statement shows you how much money flowed in and out of your business during a specific period. This statement answers a fundamental question: "Did we make money or lose money during a given period?"

Balance sheet

Unlike your P&L statement, which reveals performance over time, your balance sheet captures a single moment, like a photo of your business on a specific date. It lists everything your company owns (assets), everything it owes (liabilities), and what's left over for the owners (equity).

The balance sheet follows a simple formula known as the accounting equation:

Assets = Liabilities + Equity

This statement tells you what your company is worth at any given point and how it's financed.

Cash flow statement

The cash flow statement bridges the gap between the P&L statement and the balance sheet by tracking the actual movement of cash in three categories:

1. Operating activities (day-to-day business operations)
2. Investing activities (buying or selling long-term assets)
3. Financing activities (borrowing money or paying dividends)

You might be profitable on paper according to your P&L, but the cash flow statement reveals whether you actually have cash in the bank to pay your bills.

How they work together

Your P&L might show strong profits, but your balance sheet could reveal dangerous levels of debt that threaten your business. Or your P&L might show modest profits, while your cash flow statement reveals that customers are slow to pay, creating a cash crunch. Each statement compensates for the blind spots of the others.

For investors and lenders, these three statements work as a financial health checkup. The P&L shows whether your business model is working, the balance sheet reveals your company's stability and debt levels, and the cash flow statement confirms whether your business can meet its obligations.

Together, they provide the comprehensive view necessary to make informed decisions about your business's future.

Common mistakes to avoid when preparing a P&L statement

Accurate profit and loss reports drive informed financial decision-making. Avoiding these common mistakes supports reliable financial reporting and better business insights:

• Misclassifying expenses: This can distort your financial reports and impact your taxable income. Create a standardized chart of accounts and review classifications quarterly to maintain consistency across reporting periods.
• Ignoring tax deductions and depreciation: Overlooking these can result in overpaying taxes and misrepresenting net profit. Consider working with a tax professional to identify all eligible business tax deductions and establish depreciation schedules for assets.
• Failing to update financial records regularly: Inconsistent recordkeeping can lead to errors in cash flow analysis and budgeting. Set up monthly reconciliation procedures and use automated data entry where possible to reduce manual errors.
• Overlooking seasonal revenue fluctuations: Not accounting for seasonal trends can result in poor financial planning and cash shortages. Analyze historical data to identify patterns and create seasonal forecasts for more accurate budgeting.
• Missing revenue streams: Failing to capture all income sources can significantly understate total revenue and profitability. Conduct quarterly revenue audits to make sure you've recorded all income streams properly.

Consider using dedicated accounting software or professional P&L templates to streamline preparation, reduce errors, and maintain compliance with accounting standards. These tools often include built-in checks and automated calculations that help maintain accuracy and consistency.

Ramp: Powering P&L management

Profit and loss statements are among the three critical financial documents you’ll regularly need to prepare and report on. However, if you want continued long-term success, simply producing P&L statements won’t cut it. You must also instill a P&L responsibility ethos from the top down.

Ramp's accounting automation software can help. It integrates with your existing fintech stack to automate categorization, sync expenses in real time, and keep your profit and loss statements accurate without the manual lift. Whether you need a high-level overview or want to drill into specific spend categories, Ramp gives you the visibility and control to manage costs and forecast confidently.

Ready to learn more? Try an interactive demo and see why companies that use Ramp save an average of 5% across all spending.