A profit and loss statement, also known as an income statement, details a business's income and expenses over a defined period of time. This financial statement is particularly important for companies seeking additional capital, as it shows how past funding was invested and whether management is capable of turning a profit. Reviewing revenues and expenses by line item and comparing amounts to prior periods also helps management identify positive or negative trends in the business.
Revenue is reported first on the profit and loss statement and includes all income items. Operating revenue such as company sales is typically broken out from non-operating sources of income like interest. When using the accrual method of accounting, revenue is reported when earned, at the time of sale, even if payments have not yet been received. If the cash method is used, revenues will be recorded after payment is received. To increase the accuracy of reported income, gross sales may be adjusted based on past experience of customer returns or refund requests by setting up an allowance and netting it against revenues.
The expense portion of a profit and loss statement encompasses any expenditure made to operate the business. Advertising costs, employee salaries, interest expense, and amounts paid to vendors or contractors are all considered expenses. Some purchases, such as office equipment, must be capitalized as an asset and expensed over the useful life of the item. For example, if a $1,000 computer is purchased, it would be expensed over five years. Each year the profit and loss statement reflects 20 percent of the cost for the computer, or $200 in expense. Non-operating expenses such as interest and taxes are often broken out separately from operating expenses for illustrative purposes.
Calculation of Net Profit or Loss
If revenues exceed expenses, taxes must also be applied to income. An estimated tax rate may be used if the true amount is unknown. After calculating any taxes due and subtracting them from pre-tax income, the net amount will equal a company's profit or loss for the period. Typically, profit and loss statements are prepared on a monthly, quarterly, or annual basis. When applying for a bank loan, companies will often need to produce several years of profit and loss history, if available.
Profit and loss statements show how businesses turn expenses into profits. Small business owners should review financial statements, including a profit and loss statement, on a periodic basis to determine the health of their company. In addition to the profit and loss statement, it's also a good idea to prepare financial reports including a balance sheet and cash flows statement. To make financial statement preparation easier, an online accounting system can track revenues and expenses as they are incurred and generate these reports at the touch of a button.