How to create and analyze a profit and loss statement

Staying on top of your company’s finances takes a concerted effort—and a lot of number crunching. Fortunately, most of the data can be handled by automated processes. However, those figures are still useless if you don’t know how to appropriately analyze the data.

What is a profit and loss statement?

A profit and loss statement, or P&L, also referred to as an income statement, is a financial report that summarizes your business’ revenue and expenses during a given period of time, often a year. It describes where your company’s resources are coming from and where they’re being spent over a specified time. For increased clarity, these statements can often be broken down into fiscal quarters or even monthly periods.

A P&L statement is one of the three financial statements that every public company is required to issue on both a quarterly and annual basis.  The other two are a balance sheet and a cash flow statement. 

The P&L  provides an easy way to gauge a company’s financial health and performance based on the net profits and losses the business generated.  

According to Forbes, companies rely on comprehensive income statements to track their overall operations:  “[P&L reports] determine whether a company is profitable, and if so, by how much. Knowing how profitable their operations are in turn helps companies determine their tax liability. They can also monitor the rate at which sales are increasing or decreasing, enabling management to spot difficulties with a product or its market.”

To analyze your P&L, you’ll first need to determine whether you’re on a accrual basis or cash basis accounting: 

• Cash basis – Revenue and expenses are denoted by cash movement. So, if you agree to pay a service provider $1,000 next month, that $1,000 won’t be accounted for until it leaves your bank. ‍
• Accrual basis – In accrual basis accounting, both revenues and expenses are accounted for when they’re earned and incurred, instead of when they leave or reach the bank. 

If you’re on a cash basis, you’ll have to consider unrecorded items as you go about preparing the P&L. Denoting soon-to-be payables and accounts receivable creates a more accurate reading of your financial position for that quarter or fiscal year. You might also choose to do a year-to-date profit and loss statement to see how you’re doing so far through the year.

How to do a P&L statement?

These days, most businesses, large and small, rely on automated financial management software to develop their P&L statement. But if you don’t have one, or wish to perform the process manually in Excel or Google Sheets, you can follow these steps for a simple profit and loss statement:

1. Gather all your financial information and documentation

Much of the information that should be on your income statement can be drawn from your cash flow statement and estimated calculations on depreciation. Your focus will be largely devoted to income and expenditure. That said, you’ll need three things when creating your own P&L: 

• All the transactions in your business checking account and all purchases made on your business cards
• All petty cash transactions or other cash transactions for which you have receipts for
• Your sources of income, including credit card payments, checks, and cash payments—all of which can be found on your bank statement

2. Select your reporting period

A P&L details the business’ total revenues, total expenses, and profits or losses for a specific period of time. These constraints help you gain more actionable insights. Typically, an income statement is assessed over a month, quarter, or annual basis. So choose the right time frame for your business.

3. Find your company’s revenue

Once you have that period defined, list your business’ sales for the specified period. If you’re creating an annual income sheet, it’s helpful to break down net sales by quarter or month. Include your income sources, also broken up into smaller chunks.

4. Subtract the cost of goods sold (COGS) to find gross profits

COGS are the direct costs of producing the goods or services sold by the company. By subtracting the cost of goods sold from revenue, you can find your gross profits.

5. List your operating expenses

These operating expenses can be broken down into specific categories such as sales & marketing (S&M), research & development (R&D), and general & administrative (G&A). By adding these up, you can find your total operating expenses. Note: You canalso choose to separate by payroll expenses vs non-payroll expenses.

6. Subtract total operating costs from gross profit

This calculation leaves you with your operating income.

7. List your non-operating income 

This could include interest, revenues, and gains on the sale of investments. After adding this to your operating profit, the total equals your earnings before interest, taxes, depreciation, and amortization, also known as EBITDA. 

EBITDA = operating profit + (interest income + dividends earned)

8. Calculate interest, taxes, depreciation, and amortization 

Your next step is to calculate any interest payments, taxes, depreciation, and amortization expenses.

9. Subtract interest, taxes, depreciation, and amortization from EBITDA

This will leave you with your net income and top-line growth.

Note: It’s always a good idea to consult a professional when working on your business finances. This article is not intended as legal or financial advice.

What should you look for in a P&L statement?

There are a lot of financial metrics contained within a P&L statement. Analyzing them may seem overwhelming at first, but to make things easier, it’s helpful to break it down by category:

Sales

Your sales are the revenue generated from the sale of a product or service. This is the first metric you should be looking at because increasing sales is the most simple and direct way to increase your business profit. If there is a month of sales that stands out from others, you should take some extra time to evaluate it. Take the time to ask questions like, “What went right?” and “What factors drove sales? and “How can we mimic that going forward?” 

Cost of goods sold (COGS)

Costs of goods sold, or COGS, are the expenses that are directly related to producing your goods or service. As you’d expect, these increase in accordance with revenue. Although it may be tricky, finding places to lower the cost of goods sold can also help increase your company’s net profit margins.

For example, you may be able to buy in bulk, embrace automation, or substitute lower-cost materials where possible. That said, if cost savings reduce the quality of the product being sold, cuts may not be worthwhile.  

Earnings before tax (EBT) and EBITDA

EBT shows how much of an operating profit the business has realized before accounting for tax season. This figure makes it easier to compare the earning power of companies in different states with different tax rates.

Earnings before interest, taxes, depreciation, and amortization (EBITDA) provide a short-term window into your operational efficiency. Many investors view this as the more important measure of a company’s profitability since it accounts for non-operating factors.

Profit margins

Your profit margins are your bottom line, represented as net income as a percentage of sales.. To calculate your profit margin, simply divide net income by net revenue and then multiply by 100 to convert it into a percentage. Once you’ve done this, you can see if your margins are up, down, or if they break even.

What does P&L responsibility mean?

If you’re the owner or an executive within a company, modeling profit and loss responsibility is one of your most critical roles. In essence, P&L responsibility is all about considering ROI and then finding ways to maximize it. 

Executives charged with this are expected to pursue new profit avenues, reduce budget expenditures, and ensure that every program within the company is generating positive ROI. As a result, they’re often in charge of P&L management and the deciding factor in approving new projects or investments.

According to Blue Steps: 

“P&L responsibility involves monitoring the net income after expenses for a department or organization and influencing how company resources are allocated. Those with P&L responsibility often give final approval for new projects, find ways to cut budget expenditure, and ensure every program generates a positive ROI.”

So, how can you ensure that your company is embracing this mindset? 

• It starts at the top – Leaders must set the example in communicating the importance of being conscious about company spending.
  
  The leaders in the company must model an ethos that ensures that every employee is doing their utmost to reduce costs and create a positive impact on the company’s finances. If those who have the most to gain from such behaviors fail to embrace this attitude, there’s little chance that mid-level and lower-level employees will. ‍

• Take ownership of the good and the bad – It’s important that everyone in the business is accountable for both the business’ success as well as its failures. Top executives are expected to regularly report P&L statements to the business owners and shareholders.
  
  If mistakes do take place, they must be discussed openly and then troubleshot to avoid them going forward. Instead of pointing fingers and blaming others, it’s much better to create a culture where you identify mistakes, learn from them, and then modify your behavior. Similarly, achievements should be celebrated and then replicated. ‍

• Be willing to take calculated risks – Mistakes, like going in the red, aren’t necessarily bad things. specially if they are correctible or will generate more revenue down the line. What matters is that when an issue does happen, it’s addressed and then corrected. This ensures that your employees are operating in an environment that encourages them to push boundaries and innovate.‍

• Listen to others and encourage collaboration – A good idea can come from anyone, whether it be a high-level executive or a temp worker. If you want to drive your business forward and find new income streams, all levels of the organization must be actively involved in the conversation. By encouraging participation, you actively ensure that the company’s P&L responsibility is top of mind. ‍

• Be open to bold ideas or new technologies – Practically every business has room for optimization, especially through automation. Instead of simply accepting the status quo, teams should investigate novel technologies or processes that could be employed to increase business profitability.
  
  For instance, processes like expense report reconciliation may often be conducted on a manual basis. For the accounting teams responsible for bookkeeping, this can be a frustrating, error-prone process that could be more speedily and accurately done via automation.
  

Ramp: Driving P&L responsibility

P&L statements are one of the three critical financial documents that you’ll regularly need to compile and then report on. They provide a window into your company’s financial performance and measure growth or losses over a specific accounting period.  

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. Fortunately, Ramp can help with that.

Ramp integrates with your accounting software and provides your team with real-time visibility and control over the expenses in your business. Whether you want a high-level view of the company’s spend or want to zoom in on a specific channel, with Ramp, you gain better management overspending habits and better forecast your spend.

Sign up today to see how Ramp can drive your company’s P&L responsibility.