What is a profit & loss statement?

A P&L statement summarizes business expenses and net income for a specific period of time, typically a quarter or year. It’s a financial report business owners use for internal analysis and external reporting to interested parties. Public corporations publish their P&L as an income statement that interested parties can view, while private corporations keep it in-house. 

P&L statements are created for profit and loss management. It’s important not to confuse your profit and loss statement with your balance sheet. The balance sheet shows assets and liabilities, while the P&L shows income and expenses. There’s also a difference between the business profit on the balance sheet and the net profit on the P&L. Both metrics are important to financial planners and investors.

Profit & loss statement formula

The profit and loss format is simple. You add total revenues and subtract expenses to get your net income. That number goes at the top of the cash flow report and should match the net profit line on IRS Schedule C. It is not your available cash number. That’s calculated on the cash flow statement. Here’s what the P&L formula looks like if you need a quick reference.     

[Total Revenues - Total Expenses = Net Income]

Your revenue and expenses will change if you use a different accounting method. Accrual accounting records transactions when they occur. That includes accounts payable and accounts receivable. The IRS watches that closely, so it’s a good idea to hire a tax professional or CPA when you file your quarterly and year-end tax returns.

Profit & loss statement format

The core elements of a profit and loss statement are net sales, expenses, net income, and earnings per share. The subcategories under those headings vary by industry, but the main categories are always the same. They’re required for the P&L statement formula to work. We’ll expand on that further shortly. Suggested subcategories are listed below:

Revenue categories

Revenues are payments received and/or invoiced and recorded as accounts payable by your bookkeeping department, depending on your accounting method. Revenue will match cash flow if you’re using revenue recognition or matching. Accrual accounting counts the accounts payable portion as revenue, so the cash flow number won’t match the total revenue.    

Under revenue, you’ll typically see subcategories for sales revenue, net service sales, and other sources of income. There should also be a line for net revenue or total net sales. Most companies indent or put that line in bold to make it easy to see. Business owners and other interested parties look at that first because it shows how much money is coming in.

Expense categories

Listing expenses is more complicated. The subcategories are not universal. They are specific to the type of business and how ownership wants to report its costs.Total operating expenses are subtracted from total net sales to get a subtotal labeled “Operating Income.” Interest income is added to that subtotal. Interest expenses are subtracted, along with other income expenses. Income taxes received and paid are added/subtracted from the company’s net income.

Profit/loss (Financial reporting)

The P&L statement is designed to measure profit and loss, so “net profit” should always be on the last line. It’s calculated by subtracting total expenses from total revenue, but that’s not the whole picture. The balance sheet lists assets and liabilities, including obligations you owe but have not yet paid. True profit can’t be determined without looking at those. 

The third component is the cash flow statement. It takes the net earnings number from the bottom line of the P&L (income statement) and factors in depreciation, accounts payable, accounts receivable, and inventory. If you have investments, add gains and losses. The end result of that statement is a number for your cash on hand.

In other words, don’t look at the net revenue on the profit and loss statement as the only value you need. It’s profit for your financial reporting, but it’s not a complete picture of what’s happening at your company. Combining it with the balance sheet and cash flow statement gives you a complete view.

Income and Expenditure accounts

Profit and loss statements compiled using receipts and payments instead of the trial balance produced by accounting are called “Income and Expenditure Accounts.” This type of P&L is usually seen when companies want to see numbers for a set period, not necessarily quarterly or annual.

Income and expenditure accounts can determine a company’s surplus or deficit balance. You might see them when comparing industry averages or reporting periods. They provide clarity for investors and partners asking about the company's financial health. Ideally, you want someone in your accounting or bookkeeping department to create I&Es when requested.

Who can use a profit and loss statement?

Any business owner, partner, investor, or interested party can use a P&L, but the sections they focus on may vary. Owners concentrate on burn rate, net revenue, and overall financial performance. Analysts look at the cost of goods sold (COGS), depreciation expenses, and total income over a given period. Investors may want to see the year-to-date performance.

A P&L can also be used as a pro forma financial document to estimate business income and total expenses for a future period or secondary location. It can be combined with a pro forma balance sheet and cash flow statement to present to investors or lenders who want to see what you are projecting for operating income.

How do accounting principles affect the P&L statement?

How total revenue is calculated changes if you use a different accounting principle. This affects the gross profit of the company. The cost of sales can also change if you’re paying invoices earlier or in bulk to get better pricing. The difference for either of these is when the transaction is recorded. Here are some of the accounting principles used for a P&L: 

• Revenue recognition principle: Revenue should be recognized when earned, not when payment is received.
• Matching principle: Companies are required to record expenses in the same period as the revenues they generate
• Accrual principle: Financial transactions are recorded when they occur, regardless of when cash is received or paid out.

Let’s say you own a publishing business. Your revenue comes from retail book sales and annual or monthly subscriptions to your online platform. Revenue recognition records revenue when received, but your costs may be spread out over multiple reporting periods. A simple profit calculation won’t register all of those. Accrual accounting provides a more accurate number. 

The matching principle may skew the numbers in the other direction. All expenses are recorded in the same reporting period as your revenues, regardless of when they are paid. That means you can’t use the P&L to estimate free profit, which can affect budgeting and cash flow management. Companies that rely on cash flow may not want to use matching.

The IRS requires companies that make over $25 million in sales for three years or have inventory to use accrual accounting. There are also rules about changing accounting methods after you’ve selected one, so consider your options carefully before deciding which is best for you.

‍Please consult with a tax professional for additional guidance on your situation. 

Wrap up

For businesses, staying on top of P&L management is critical for driving success, maintaining financial health, and having a clearer picture of runway.

Rho offers enhanced visibility into your finances, provides robust spend control mechanisms, and automates many aspects of financial tracking and reporting. With access to real-time financial information, business leaders can make more strategic and informed decisions.

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Kevin Flynn is a guest contributor. The views expressed are his and do not necessarily reflect the views of Rho.

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Note: This content is for informational purposes only. It doesn't necessarily reflect the views of Rho and should not be construed as legal, tax, benefits, financial, accounting, or other advice. If you need specific advice for your business, please consult with an expert, as rules and regulations change regularly.